There’s a good chance that Americans’ total credit card balances will soon hit a new all-time high, marking a sharp reversal from the sharp decline in 2020 and early 2021.
According to the New York Fed Quarterly Report on Household Debt and Creditcredit card balances peaked at $927 billion in the fourth quarter of 2019. They fell in four of the following five quarters as the COVID-19 pandemic took hold, hitting a low of $770 billion in first quarter of 2021 (a 16.9% decline from peak to trough).
Since then, credit card balances have increased for three consecutive quarters, reaching $856 billion in the fourth quarter of 2021 (7.7% lower than the record set in the fourth quarter of 2019). When the New York Fed releases Q1 2022 data on May 10, it will likely be close to the all-time high.
Credit card spending jumped in the first quarter
On its April 22 earnings call, American Express said its customers spent more in March 2022 than any other month on record. Cardholder spending increased by 35% in the first quarter of 2022 compared to the comparable period of 2021.
Capital One saw a 26% increase in purchase volume year over year. And Chase noted a 21% year-over-year increase on its first-quarter earnings call (credit and debit cards combined), adding that credit growth was stronger than debit.
The Federal Reserve’s monthly consumer credit reports (G.19) also showed a sharp increase in credit card balances. The most recent release (March 2022) showed a staggering 35.3% annualized increase in revolving debt (which is mostly credit card debt). This is the largest percentage increase since April 1998. Total revolving debt is now just 0.2 percentage points below the all-time high set in February 2020.
This is largely due to robust consumer spending, of course, but credit and debit cards have been helped by the growth of e-commerce and the continued migration of cash. It’s great if you can pay in full, avoid interest, and earn rewards, but it can be very expensive if you pay interest every month.
Lately, credit cards also seem to benefit from a behavioral quirk: Many Americans prefer to use debit cards for daily necessities, but place larger discretionary purchases such as travel on credit cards. As the COVID-19 pandemic appears to be receding, some spending is shifting away from goods and towards services such as airline tickets and hotel stays, which tends to favor credit cards over cash. debit cards. We also need to acknowledge the highest inflation readings in 40 years as a driver of increased spending and higher credit card balances.
What’s next for debt balances?
This all adds up to the likelihood that total credit card balances will set a new record by the middle of this year. It would take an 8.3% quarterly increase over the New York Fed’s fourth quarter balances to top the previous record. That might be a bit steep for the May 10 report, but it’ll likely be close. Credit card balances increased by 6.5% between the third quarter of 2021 and the fourth quarter. The latest figures reported by Amex, Capital One, Chase and the G.19 report indicate that spending growth accelerated in the first quarter, so it’s possible.
In contrast, it took more than five years for credit card balances to bottom out during and after the financial crisis (from a peak of $866 billion in the fourth quarter of 2008 to a low of $659 billion in first quarter of 2014). It then took almost five more years (until the fourth quarter of 2018) to eclipse the previous record. It was slow compared to our current situation.
Interest rates are also rising
Unfortunately for anyone with credit card debt, that debt is about to get even more expensive. In an effort to fight inflation, the Federal Reserve raised the federal funds rate by 25 basis points in March and another 50 points earlier this week. This is just the beginning. According to FedWatch CME Tool. These higher rates are usually passed on to credit cardholders within a month or two and apply to existing balances as well as new purchases.
Later this year, the cumulative effect is expected to push the average credit card interest rate (currently 16.41%, according to Bankrate) to over 18%. To date, the record is 17.87% (set in April 2019).
At the time, the prime rate (which is typically three percentage points higher than the federal funds rate) was 5.5%, so the average margin was 12.37% (17.87 minus 5, 5). The prime rate just went up from 3.5% to 4%, but since it will take a bit of time to work its way through the system, a more apples-to-apples comparison shows that the recent average margin was 12 .91 percentage points (16.41 minus 3.5). If the prime rate ends the year at 6% and the average margin stays about the same, the average credit card rate could even knock on the door of 19% once the dust settles.
Experian says the average credit card balance is $5,525. If you make minimum payments at 16.41%, it will take you 195 months to pay off the entire amount and you will end up paying a total of $6,276 in interest. At 18.91%, it will take six more months and require $1,040 in additional interest payments.
what you should do
My best advice for people in debt is to get a 0% balance transfer card. These offers last up to 21 months and can save you a ton of money in interest. I mentioned earlier the horrible calculation of the minimum payment. But even carrying a credit card balance of $5,525 for 21 months at 16.4% isn’t pretty. This would result in a total interest bill of $868 and require monthly payments of approximately $304.
In contrast, with a 0% balance transfer card, you can make 21 equal payments of about $275 to eliminate that $5,525 without paying interest (assuming the typical balance transfer fee of 3 to 5%, which is $166 to $276 on a balance of $5,525). Still, it’s worth it as long as you can pay off your debt within the time frame. Here are my favorite balance transfer cards:
- Wells Fargo Reflect℠ Card: Up to 21 months with 0% interest on balance transfers and new purchases (provided all payments are made on time). Beyond that, the variable APR is 13.24% to 25.24%. There is a reduced balance transfer fee of 3% ($5 minimum) within the first 120 days. It then goes to 5%.
- Citi® Diamond Preferred® Card: 21 months interest-free on balance transfers and 12 months on new purchases. The standard variable APR ranges from 13.99% to 23.99%. The balance transfer fee is the greater of 5% or $5.
- Citi Simplicity® Card: 21 months interest-free on balance transfers and 12 months interest-free on new purchases. Regular variable APR from 14.99% to 24.99%. There is a balance transfer fee of 5% or $5, whichever is greater.
Some good news
While credit card balances and record interest rates are troubling statistics, the glass is half full in some ways. Credit card chargebacks and household debt service payments as a percentage of personal disposable income are both near record lows. Moreover, the share of credit card holders pay their bills in full is close to a record high.
“While a prolonged high inflation environment will negatively impact many consumers, severe default rates will generally not rise above pre-pandemic levels, even under worst-case inflation scenarios” , said Charlie Wise, senior vice president and head of global research. and consulting at TransUnion. “Furthermore, consumer credit markets are likely to experience more positive credit behavior once inflation subsides.”
The bottom line
Still, there are warning signs on the horizon. All news is local, and for about half of credit cardholders who carry expensive balances month to month, the burden is growing. Higher costs and higher interest rates could send credit card balances to the races. This could create a vicious circle of consumers falling behind on payments or reducing discretionary spending, which could prove problematic for our consumer-driven economy.
Have a question about credit cards? Email me at [email protected] and I’d be happy to help.