Action Line: Credit card APRs rely on prime rate, margin
BY PHIL MULKINS World Action Line Editor
Tuesday, December 04, 2012
12/04/12 at 6:58 AM
Dear Action Line: I'm sick to death of the "federal funds rate fiasco" - the Federal Reserve Board playing god with the prime rate to "help the economy" but, as an unintended result, keeping credit card APRs sky-high. Explain this, please. - M.T., Jenks
The Bankrate.com website says the "federal funds rate" is the interest rate at which banks and other depository institutions lend money to one another, usually on an overnight basis. The law requires banks to keep a certain percentage of their customers' money on reserve, where the banks earn no interest on it. Banks stay as close to the reserve limit as possible without going under it, lending money to maintain an optimum level.
As with the "federal discount rate," the FFR is used to control the supply of available funds and thus inflation and other interest rates. "Raising the rate makes borrowing more expensive. That lowers the supply of available money, which increases the short-term interest rates and helps keep inflation in check. Lowering the rate has the opposite effect, bringing short-term interest rates down. The 0.25 percent rate has pressed mortgage rates to record lows but has not had the same effect on credit card rates."
Bill Hardekopf, CEO of the credit card rate monitor LowCards.com, says: "The interest rate on most credit cards is influenced by the prime rate, but lending risk is a much bigger factor in determining a consumer's interest rate. In September, the Federal Reserve again locked the lid on interest rates in its ongoing attempt to stimulate the economy. The Fed has kept the FFR at its historically low zero to 0.25 percent and announced this would remain policy through mid-2015. This sounds like good news for consumers, but don't expect such actions to lower your credit card APRs."
The FFR has been near zero since 2009 - compared to 5.25 percent in 2007. Committing to this low rate for three more years is unusual, but the Federal Reserve wants to provide stability to borrowing and spending, as well as helping boost the economy, Hardekopf said. Credit cards are now mostly "variable rate cards" as "fixed rate cards" are very difficult to find. The interest rate on a variable rate card is made up of two factors: index and margin.
Index: The index used by most variable rate cards is the prime rate. The prime rate is made up of the FFR - set by the Fed's Open Market Committee - plus 3 percent. The FFR has remained at or under 0.25 percent since December 2008. The prime rate has remained at 3.25 percent.
Margin: This is the additional interest rate added by the issuer for taking the risk in making this loan, which on most credit cards is an unsecured short-term loan. The higher the risk of a particular consumer, the greater the margin the issuer will assess. The average advertised credit card APR for the past year is about 14.34 percent.
Original Print Headline: Prime rate, margin set credit card APRs
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