Why Does the Prime Rate Affect My Credit Card APR?
If you have a credit card, you may wonder how the annual percentage rate (APR) is determined.
The APR is indirectly tied to the federal funds rate, which is the interest rate at which banks and financial institutions lend to one another. Since 2015, the Federal Reserve Bank has raised the federal funds rate eight times. When the federal funds rate rises, other benchmark interest rates can rise as well.
One of those benchmarks is the prime rate. The prime rate represents the interest rate banks charge their most creditworthy customers to borrow money. It's usually calculated as the federal funds rate, plus three percent.
So what does this mean for credit card holders? Here's a quick primer on interest rates and their relationship to the consumer:
How the Federal Reserve Impacts Interest Rates
The Federal Reserve sets interest rate policy for the federal funds rate. Rate hikes usually occur when the economy is strong; they can be effective in helping to curb the potential for inflation. Inflation is a period of steadily rising prices for consumer goods.
However, the Federal Reserve doesn't set the prime rate itself. When there's a change in the federal funds rate, either an increase or a decrease, the prime rate usually moves in tandem. If the federal funds rate goes up, for example, borrowing money becomes more expensive.
Prime Rate and Your Credit Card's APR
Interest rates for credit cards, loans and other types of credit can be fixed or variable. A fixed rate stays the same but variable rates are tied to an index rate—such as the prime rate. When the prime rate changes, the variable rate changes as well.
Credit cards typically have variable APRs. Banks may offer one variable APR to all of its customers or use a range of rates. The APR is based on the prime rate, plus a set number of percentage points the bank decides to add.
For example, the prime rate may be 5.50 percent. The bank may add 9.99 to 15.99 percent to that figure, resulting in an APR range of 15.49 to 21.49 percent. The actual APR you are assigned is based on your creditworthiness.
Your credit card APR is subject to what's essentially a trickle-down effect when rates rise. The Federal Reserve increases the federal funds rate, which causes the prime rate to increase, which means your credit card APR increases. As the prime rate rises, it becomes even more important to look for a low APR credit card, such as Barclaycard Ring.
Federal interest rate movements can impact every type of transaction you make with your card. For instance, your bank may charge one APR for purchases, another for balance transfers and yet another for cash advances.
What's Next for Interest Rates?
There's speculation that the Federal Reserve may move ahead with additional rate hikes, including one or two for 2019. If that holds true, the prime rate could increase to 6 percent by 2020, potentially making all types of loans more costly for borrowers. The timing and the likelihood of future rate hikes largely depends on the strength of the economy and overall economic conditions.
All content provided in this blog is supplied by Rebecca Lake and is for informational purposes only. Barclays takes no position as to the views, and makes no representations as to the accuracy or completeness of any information contained in the blog or found by following any link within this blog.