A healthy economy can be a dangerous thing.
Americans have a history of loading up on debt in good times, then paying dearly when the bills come due. Adding to the pain: A booming economy is often accompanied by rising interest rates, which make mortgages, credit cards and other debt much more expensive.
As the U.S. Federal Reserve raises rates, there are signs that consumers could be putting themselves in peril.
“When consumers are confident, or overconfident, is when they get into credit card trouble,” said Todd Christensen, education manager at Debt Reduction Services Inc. in Boise, Idaho. The nonprofit credit counseling service has seen a noticeable uptick in people looking for help with their debt, he said.
Spending on U.S. general purpose credit cards surged 9.4% last year to $3.5 trillion, according to industry newsletter Nilson Report. Card delinquencies are also rising. U.S. household debt climbed in the fourth quarter at the fastest pace since 2007, according to the Federal Reserve.
The Fed is steadily hiking interest rates, most recently on March 21 when the federal funds rate rose a quarter of a point to a target range of 1.5% to 1.75%. Libor, a benchmark rate that the world’s biggest banks charge each other, is also on the rise.
To be sure, overall economic trends are anything but gloomy. The savings rate is headed back up, while real wages are on the rise and recent tax cuts could help fatten some peoples’ wallets.
In fact, the typical American might not notice much pain from rising rates — at least for now. The vast majority of mortgages, auto loans and student debt are taken out at fixed rates, guaranteed for the life of the loan. New loans are linked to long-term rates, which haven’t risen along with short-term Libor and fed funds rates.
Adjustable-rate mortgages, or ARMs, are often tied to Libor, typically resetting once a year. ARMs proved to be a big problem during the housing bust, when it became clear that many Americans were using them to buy houses that they otherwise couldn’t afford.
A decade after the financial crisis, the good news is that ARMs are far rarer — and their holders should be able to afford, or avoid, rate hikes.
That leaves rising rates on credit card debt as the biggest financial worry for many U.S. families. Card debt is typically based on a “prime rate” that’s directly linked to the fed funds rate. If the Fed pushes through a quarter-point increase, your card’s rate could go up by the same amount a month or two later.
If you owe money on your credit card, however, an extra quarter point might not make much difference. Take, for example, a consumer who owes $1,000 on a card with a 19% annual rate. If she only meets the minimum payments, Credit Karma estimates she won’t pay off the debt for more than five years, racking up $600 in total interest charges over that time period. If the interest rate goes up by a quarter point, she’ll end up paying just $16 extra in interest.
Still, there are reasons to worry about consumers’ credit card debt load, long term. Use of credit cards is rising faster than debit cards as banks offer users lucrative rewards.