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Because of the extremely high interest rates, credit cards are one of the most expensive ways to borrow money.
Even so, at least one-third of credit card users carry a balance from one month to the next, according to the Federal Reserve Bank of Boston.
However, a new paper published by the Boston Fed found that when credit card interest rates change, cardholders adjust their spending accordingly.
On average, a 1 percentage point increase in the annual percentage rate, or APR, on a credit card leads to a roughly 9% drop in credit card spending the following month — which is an “economically meaningful response,” the researchers found.
When borrowing becomes more expensive and consumers spend less on their cards, they also reduce their debt burden, the report found.
“It appears that many people do slow spending to the extent they can when interest rates go up,” said Ted Rossman, senior industry analyst at Bankrate.
“We’re seeing a similar phenomenon with gas prices — there’s evidence that many people are driving less and combining trips when possible due to recent price increases,” he said. “Consumer spending, therefore, may be more rational than a lot of people realize.”
How the Fed affects your credit card rate
Generally, credit card rates are closely pegged to the prime rate, which is the rate that banks charge their most creditworthy customers — typically 3 percentage points above the federal funds rate, which is set by the Federal Reserve’s Federal Open Market Committee.
When the Fed raises or lowers rates, the prime rate moves as well, and the interest rate on that credit card debt is likely to follow within a billing cycle or two.
Following the Fed’s rate hikes in 2022 and 2023, the average credit card rate rose from just over 16% to more than 20%, reaching an all-time high in 2024. APRs have since edged down to around 19.58%, on average, according to Bankrate.
Despite some reports showing that cardholders who carry a balance don’t know the interest rate they’re being charged, “this data shows me that people who carry a balance are acutely aware of the interest rates on their credit cards and adjust their behavior, at least to some degree, when those rates change,” said Matt Schulz, chief credit analyst at LendingTree. “That’s a good thing.”
According to the Federal Reserve Bank of Boston, a 9% decline in spending due to a 1 percentage point higher APR amounts to about $74 less per month in credit card charges. However, these changes do not happen across the board.
“Financially constrained consumers … are most responsive,” said Falk Brauning, an economist at the Federal Reserve Bank of Boston and co-author of the report.
For those who carry a balance, a 1 percentage point increase in the APR reduces spending by as much as 15% the following month, largely because these borrowers likely have fewer financial resources and limited access to alternative forms of credit, Brauning said. “Being a revolver or not is very much correlated to your financial status.”
Alternatively, those who pay off their balance in full at the end of the month do not respond significantly to interest rate changes, the Boston Fed found. “This finding is intuitive: If you are not paying interest, a higher interest rate does not directly increase the cost of your purchases,” the report said.
“There’s also a strong K-shaped economy take on this: It’s upper-income households powering the economy forward, even as lower- and middle-income households cut back,” Rossman said.
The Fed’s next move
Since December, the federal funds rate has remained steady in a target range of 3.5% to 3.75%, and credit card rates have barely budged. Futures market pricing is implying almost no chance of a rate cut at the next meeting in April, according to the CME Group’s FedWatch gauge. In fact, the central bank is largely expected to stay on hold through the first half of the year.
At the same time, soaring energy costs and rising concerns about stagflation are pushing markets to consider that the Fed’s next move could be a rate hike.
As recently as Friday morning, traders in the futures market raised the probability of a rate increase by the end of 2026, according to the CME Group FedWatch tool.
On Monday, Fed Chair Jerome Powell said that “inflation expectations do appear to be well anchored,” so the central bank doesn’t need to raise rates just yet.