What do they have in common? According to credit.com, If the Debt Ceiling Isn’t Raised, Your Credit Card’s Interest Rate Will Be. Briefly, the author says that a failure to raise the debt ceiling would cause the U.S. to pay higher interest rates on its debt. She says that if the U.S.’s rates rise, it will cause the Prime rate to rise.* Do you remember Prime rate?
Where have we heard of Prime rate before… Where…
Oh, yes, I remember! We talked about how Prime rate was the basis of calculating the interest rate on the offer Discover® sent me. Here was one of the scary charts I made illustrating how exposed I would’ve been to interest rate changes if I would’ve gotten the card.
Looks like no fun to me. Now, here’s the thing: if what the author of the credit.com article is true, then there may be a pretty significant problem coming down the pike to people who carry a balance on their credit cards.
So, if Prime rate jumps from 4% to 8%, then a card at Prime + 11.99% would go from 15.99% to 19.99%. (Are you impressed with my arithmetic?) So the cost per thousand of borrowing would go from $13.33 per month (=($1,000 x 15.99%)/12) to $16.66 per month (=($1,000 x 19.99%)/12). While that doesn’t seem like much, most households measure their credit card debt in multiple thousands. I bet if you were to ask Mr. or Ms. Average, they would neither know what Prime rate is, nor would they know how it drives the interest rates on their credit cards.
The point of all this being: carrying credit balances that you can’t pay off for an extended period of time exposes you to the risk that interest rates will move against you. The danger is most acute for people who both carry balances they can’t quickly pay off and have very little margin between their monthly expenses and income (that is to say, those living paycheck to paycheck.) This is why we frequently recommend that households only have one credit card, and that they use it sparingly.
* I don’t necessarily hold to that. Remember, I’m not the one making the prediction, she is.