The Fed slashed rates to almost zero — what that means for your credit cards

Mar 27, 2020

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On Sunday, March 15, the Federal Reserve cut its benchmark interest rate to almost zero. This emergency move to help protect the economy during the COVID-19 pandemic has only been done once before — during the financial crisis of 2008. The new feds funds rate, which financial institutions use as a guide for short-term lending and consumer rates, is now targeted at 0% to 0.25%.

What does this rate slash mean for cardholders? I sat down with Bankrate’s U.S. economics reporter Sarah Foster to discuss how the Fed’s rate cut impacts cardholders.

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What is “the Fed” and what does it do?

The Federal Reserve, America’s centralized bank, plays a large role in the overall economic health of U.S. financial institutions. Investors and economists look to the Fed to steer the financial system in America, but what the Fed does impacts more than just those in the finance industry.

The Federal Open Market Committee (FOMC), made up of the board of governors and the 12 regional reserve banks, comes together to conduct monetary policy and set the benchmark for interest rates. The Fed can help make sure the U.S. economy doesn’t grow too fast (which can cause a crash), but it also helps the U.S. maintain financial stability in a recession or other times of distress (such as the COVID-19 pandemic).

While the Fed has a number of responsibilities pertaining to economic policy, it garners the most attention when the FOMC sets interest rates. During times of financial crisis, the Fed can cut rates to help prop up the U.S. economy so that it can weather the storm — which is what they’ve done by slashing rates to essentially zero.

What does the Fed rate have to do with credit cards?

“When people say the Fed ‘cut’ rates, they actually mean the Fed reduced an interest rate that serves as a benchmark for other borrowing costs,” explains Foster. “Basically, when the Fed’s rate falls, so do others. It’s distributed throughout the economy as a result.”

The prime rate — the interest rate commercial banks use as a starting point for the interest rates they charge customers—  is one example of a rate that is directly affected by the Fed’s rate. This means that a cut in the Fed’s rate could mean a change in the annual percentage rate (APR) on your credit card.

(Photo by Isabelle Raphael / The Points Guy)
Fed rate cuts can translate into lower APRs on your credit cards, which can make it easier to pay down debt. (Photo by Isabelle Raphael / The Points Guy)

Potential for lower APRs, but no guarantee

After the Fed cut rates earlier this week, the U.S. prime rate was set to 3.25%. Now, credit card companies charge a steep margin on top of the prime rate. It’s one of the ways they make money, in addition to fees, such as an annual fee. That’s why credit card debt is generally more expensive than some other types — while the prime rate has hovered between 4.0% and 5.5% over the past couple of years, the average credit card APR has been closer to around 16% to 17%.

Let’s (optimistically) assume that issuers keep the margin of what they charge on top of the prime rate the same. Over the past year, the prime rate has dropped from 5.5% in July 2019 to 3.25% in March 2020 — a 2.25% drop. According to the rate report on CreditCards.com, the average APR in July 2019 peaked at 17.8%. That would mean we could potentially see the average APR drop to 15.55%.

For those who pay off their balance in full each month, that change would have no effect on you at all. But if you do have a balance right now, you could potentially see your APR lower. But keep in mind that this decrease would more than likely have a minimal impact on your monthly payment.

Related reading: Ways to use a credit card responsibly 

Plus, there is no guarantee that a significant APR drop will happen. As of now, rates have dropped from an average of 17.54% six months ago to 16.69% after the Fed rate cut, but that’s based on an average across credit cards. Your specific cards may even have rates that rise.

“Of course, it’s not even a sure deal that credit card issuers will even reduce their APRs by [2.25%],” says Foster. “They are a business, and they have to make money. During the recession, some credit card rates continued to rise, even though the Fed kept rates at near-zero for more than half a decade. This is why credit card debt comes with a heavy price tag.”

Using 0% APR credit cards

While a lower interest rate from the recent Fed rate cut may not have a massive impact on your credit card debt, one option to avoid interest when paying down debt or financing larger purchases is a 0% APR credit card.

Some cards offer a certain period of time (generally between 12 and 18 months) where you won’t be charged interest on new purchases, balance transfers or both. If you have credit card balances that are accruing interest each month, you can save a lot of money by transferring those balances over to a balance transfer credit card and paying off that debt during the 0% APR period.

Alternatively, if you know you’ll need to carry a balance to either make ends meet over the next few months or to finance a larger purchase (some TPG staffers have invested in Pelotons, for example), you can use a card with a 0% APR intro period on new purchases to give you extra time to pay off expenses.

In either case, just make sure you’re paying off your balance before the intro period ends to avoid racking up interest once the regular APR kicks in.

Bottom line

The Fed rate cut plays a significant role in the overall financial ecosystem. Cutting rates incentivizes banks to lend out money and can encourage consumer spending. Both help funnel money into the economy.

“Purchases provide revenue to businesses, which is in turn, key for ensuring that firms stay afloat and employees keep their jobs,” explains Foster. “Think of it in the context of coronavirus-related shutdowns: Small businesses and restaurants have seen a sudden drop in their sales, and many are understandably worried that they won’t survive as a result. When interest rates are low and consumers spend rather than save, it keeps the wheels of the economy turning.”

Related reading: How you can help small businesses during COVID-19

But while a 0% to 0.25% Fed rate will likely have a serious impact on the overall financial health of the nation, the direct cut on your monthly credit card balance will likely be small.

At TPG, we encourage paying off your bills in full each month. Of course, in times like these, that may not always be feasible for every cardholder. For those who do have to hold a balance, the rate cut from the Fed could mean a lower APR — at least in the short term.

Featured image by Rudy Sulgan/Getty.

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Balance Transfer Fee
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