How Interest Rates Affect Credit Card Delinquencies

When the Federal Reserve raises or lowers interest rates, it always triggers the same question among consumers—how will a rate cut or hike affect me financially?

Declining rates are often positive for those with a credit card or other high-interest debt. However, just how much of an impact does a rate decrease really have on credit card users and their ability to pay back their balances?

These are important questions in light of the current pace of credit card delinquency rates. Taking a closer look at the numbers can help put delinquencies and rates in perspective.

Key Takeaways

  • Credit card delinquency rates hit a multi-decade low as of the third quarter of 2021.
  • The drop in the past year is mainly due to the COVID-19 pandemic.
  • The average credit card interest rate is 16.13% as of November 2021.
  • Not every credit card company adjusts interest rates to track the federal funds rate.

Credit Card Delinquency Rate

Coming off the heels of the Great Recession of 2008, credit card delinquencies hit a peak in the second quarter of 2009. The delinquency rate reached 6.77% before gradually dropping back down to 2.12% through the second quarter of 2015. The delinquency rate rose up back to 2.66% in the first quarter of 2020 and since then has slowly been declining. As of the third quarter of 2021, the delinquency rate for credit cards issued across all commercial banks was 1.57%. The rate is significative lower than the peak of 6.77% reached in 2009.

Credit Card Interest Rates

Rising rates can contribute to higher delinquency rates. For a borrower who’s just making the minimum payment each month or only paying a few dollars more, a higher APR could make it difficult to make a dent in the principal. If you’re struggling to keep up with other financial obligations—a mortgage payment, medical expenses, or, in the case of younger borrowers, college tuition—keeping up with a credit card payment could get pushed to the back burner.

Credit card interest rates are set based on the prime rate, which is the lowest rate at which banks lend to the most qualified borrowers, and the prime rate is influenced by the federal funds rate.

Over the last several years, the uptick in credit card delinquencies was parallel to an increase in credit card interest rates. The average credit card annual percentage rate (APR) reached a low of 12.94% in 2014. But in 2019, nearly five years later, the average credit card rate across all commercial banks had reached 16.97%.

As of February 2022, the average credit card interest rate is 16.13%. The Federal Reserve announced in March 2020 an emergency rate cut to help protect the economy during the COVID-19 pandemic, lowering interest rates to near zero. Prior to this, pushing benchmark interest rates had only been done once before, during the global recession of 2008.

Will Credit Card Delinquencies Rise?

When consumers are spending on credit cards at a consistent rate, there’s very little incentive for credit card companies to lower interest rates. So even when the Fed decides to lower rates, consumers may see very little tangible benefit where their card’s APR is concerned.

Credit cards as a form of payment have steadily increased since 2016, going from 24% of payments in 2019 to 27% of payments in 2020. This could be due to the COVID-19 as consumers tend to do most of their shopping online or use credit cards instead of cash to avoid contact with others.

Also, when credit card companies expand credit card availability to subprime borrowers, the odds of higher delinquency rates can also increase. Subprime borrowers tend to have a riskier credit profile overall, which could make delinquencies a stronger possibility, despite any rate drop.

Consumer credit card balances rose to $800 billion in Q3 2021. That's a $17 billion increase from $787 billion in Q2 2021.

What You Can Do to Avoid Delinquency

Credit card companies could continue to lower rates slightly, but it’s not guaranteed. In the meantime, there are some things credit card users can do to manage their balances and minimize the chances of delinquency.

Transferring balances to a card with a 0% APR can cut down on the amount of interest paid. That can also allow cardholders to pay down balances faster when more of their monthly payment goes toward the principal. Revisiting your budget and sticking to a debt repayment strategy, such as the debt snowball method, can also help you stay on top of credit card debt, regardless of what interest rates do.

Article Sources
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  5. Federal Reserve Bank of New York. "Center for Microeconomic Data."