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What the Fed decision means for your wallet — and your credit card bill

All eyes were on Federal Reserve Chairman Jerome Powell as the market digested the news Wednesday on what the central bank will do to keep the economy rebounding from the pandemic while countering the hot inflation that has consumers’ wallets sizzling.

Market observers were betting the Fed will conclude its bond buying — a move to help the economy in the pandemic’s earlier phases — quicker than expected and chart a course for more interest rate hikes.

The Fed said Wednesday afternoon it would reduce its bond purchases to $30 billion a month so it could end the program in March, instead of June. The Fed penciled in three rate hikes in 2022, instead of one hike.

Powell was scheduled to talk about the decision at a Wednesday afternoon press conference.

In the meantime, some experts say consumers can do their own preparation for the Fed decision: Try to pay off their own credit card bills as fast as possible now in order to avoid the extra interest rate costs waiting in future.

This is because annual percentage rates (APR) on credit cards hinge closely on the rates and targets set by the Fed, experts told MarketWatch.

Credit card issuers generally start their calculations on APR by looking at the U.S. prime rate, which is the rate that banks would extend to preferred customers.

When banks determine the prime rate, they are looking at factors including the target level of the federal funds rate. (That’s the interest rate set by the Federal Reserve committee determining what banks charge each other for short-term, overnight loans.)

Layer on extra lending costs, like the so-called “credit risk” of a potential customer, and that’s essentially the ingredients of a credit card’s APR, said Steve Rick, chief economist at CUNA Mutual Group, which provides insurance products and wealth management services to credit unions.

So when Fed rate hikes zoom into view and then happen, consumers quickly can have their own future rate hikes to absorb. That’s worth knowing during a bustling holiday season amid rising costs.

“The best financial move they can make is pay off that credit card balance,” Rick said.

If banks “see rate increases on the horizon and they anticipate changes like a taper, you may end seeing rates increase for different types of loans,” said Matt Schulz, LendingTree’s chief credit analyst.

“Credit cards are among the most influenced by the Fed because so many credit card interest rates are based on the prime rate,” he said. “If you have credit card debt now, it would probably be a good idea to assume that your rates are going to go up in the not-too-distant future. If you can put a little more to credit card debt to knock it down, the better off you are.”

Following even a quarter percentage point increase in the fed funds rate, it historically takes credit card companies one or two months to bring on higher APRs, Schulz said. That’s one or two billing cycles, but, Schulz added, “They could do it the next day.”

The average APR on all new card offers was 19.55% this month, up from 19.49% in November, according to LendingTree. The maximum APR was 23.21% and the minimum was 15.89%, according to the online platform where people can shop around on credit card offers, car loans and mortgages.

Suppose a person has a $5,000 balance on their credit card and an APR between 19% and 20%, said Schulz. A single percentage point increase would tack on approximately $70 to $80 to completely pay the owed amount, plus interest, he said.

That might not sound like a lot to some people, Schulz said. “When you are living paycheck to paycheck, trying to knock that debt really does matter.”

Smaller added costs matter even for financially secure households watching rising prices burn into their disposable income. And the timing on the Fed decision matters too because the closely-watched decision comes during the holiday season.

Typically, consumers incur “modest” increases in their credit card balances during the second and third quarters, according to Federal Reserve Bank of New York data. Then, balances balloon during the holiday season in the fourth quarter and people pay off the balances in the first quarter, researchers said. Then the cycle repeats itself.

On this go-round, there could be higher credit card costs waiting for people in 2022 when they are paying off their 2021 holiday spending spree and traveling to make up lost time with friends and family.

Holiday shopping could break records this year and reach $859 billion sales, according to the National Retail Federation.

Americans held roughly $800 billion in credit card debt during the third quarter, the Federal Reserve Bank of New York said. That’s a $17 billion increase from the second quarter, but the balance is still $123 billion lower than pre-pandemic levels at the end of 2019.

Fed decisions can also influence the rates on auto loans, where rates are influenced by interest rates on Treasury notes, Rick noted. As of October, the average APR on a five-year auto loan for a new car was 3.89% and 6.12% for a used car, according to Bankrate.com. But some current offers were in the 2.5% range, the site noted.

So does that mean people should get a loan now for a new ride? Rick doesn’t think so.

For one thing, there’s an inventory problem with cars, like so many other products snarled in the current supply chain woes. Besides, Rick ultimately thinks car prices will fall as supply-chain issues ease. The savings from lower costs will be greater than the added costs of higher interest in his view.

Likewise, Schulz said, “by the time the auto loan rate go up, hopefully we will see auto prices revert a little more to normal and everything balances out.”

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