Managing Credit Card Debt as Interest Rates Rise

While the inflation rate has recently declined, the Federal Reserve raised the key interest rates by a quarter point in July 2023 and indicated another hike is being considered in the coming months. The increase raised the federal funds rate to a range of 5.25% – 5.50%, the highest level in 22 years.

While higher interest rates are great for those who want to park some short-term cash and earn interest, the higher rates can be detrimental to those who have existing debt or are seeking loans.

Each time the Fed raises the rate, the lending rates that banks charge their customers tend to follow. This means consumer debt, especially variable-rate credit card debt and variable Home Equity Line of Credit (HELOC), will get more expensive.

Expect to see your interest rates rise within a few statements.  According to Forbes Advisor weekly credit card rates report, the average credit card interest rate is 24.52%.  For comparison, the average credit card interest rate 10 years ago (2013) was 11.9% and 5 years ago (2018) was 14.22%.

This is not a concern If you pay off your bill in full every month. However, if  you carry a balance, and especially if you only pay the minimum amount due, you will be spending more of your dollars on interest, and it will take even longer to pay off what you owe.

Options to Reduce or Eliminate Credit Card Debt

·       If you have some surplus cash in the bank, especially if it is earning no or low interest, use that money to pay off or pay down debt.

·       Consider finding a good balance-transfer card with an initial 0% rate and make a plan to pay off what you owe in the coming months before the higher rate begins. Before doing this, look at the balance-transfer fees or annual fees.

·       Make payments on time to avoid additional late fees.

·       Contact the card issuer and negotiate a lower APR.  There is no guarantee that your request will be granted, but if you have a good credit score and a good record of making payments on time, the company may consider it. It can’t hurt to ask.

·       If a zero-balance card is not available, consider a personal loan with a bank with a fixed interest rate.

When you don’t pay your balance in full, the unpaid balance carries to the next billing cycle, and accrues interest. Credit card companies calculate the interest you will pay based on your average daily balance during the billing cycle.  The company adds interest every day and subtracts payments as you submit them. At the end of your billing cycle, your daily balances are added together and divided by the number of days in the cycle to determine your average daily balance.

Popular Strategies to Pay Off Credit Cards

Avalanche Strategy

This strategy saves you money by focusing your payments on the most expensive (highest APR) cards first.  Make the minimum payment on all your credit cards each month, and apply any extra payments you can, toward the card with the highest interest rates. Once you eliminate the debt on that card, take the money you were paying on it and apply to the credit card with the next highest interest rate. Continue this process until all the cards are paid off. You will have saved the most money by paying off the higher APR first.

Snowball Strategy

This strategy focuses on eliminating the number of credit card balances you have and eliminating the debt on the card with the lowest balance. 

When you pay off the smallest balance, take the money you were using to make that card’s payment and apply it to the card with the next lowest balance. Continue to make the minimum monthly payment on all cards. Repeat this process until all cards are paid off. 

Each time you eliminate a card, it is a small victory and may help build momentum and motivation to eliminate your debt.
The avalanche will save you the most money, but the snowball will provide a psychological boost. Use whichever method will best help you stay on track.

The information contained in this article is provided for informational purposes only and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional for your specific situation.

Filed under: Dollars & Sense, Life, News
Profile photo of Penny Wasem, CPA, CFP, PFS, owner of Lifetime Financial Planning Solutions in Lancaster, Ohio.

By Penny Wasem, CPA, CFP, PFS

Penny L. Wasem is the owner of Lifetime Financial Planning Solutions, LLC. A summa cum laude graduate of Ohio University, Penny earned a Bachelor of Business Administration with focus in accounting and mathematics. She serves on the board of The Fairfield Medical Center Foundation, is a member of the Investment Committee of The Fairfield County Foundation and has been active on many non-profit boards in the community. Penny lives in Lancaster with her husband Eric Hubbard and is parent to Clark and Olivia Hubbard.