Fed Rate Hike Hits Card Debt First, Raising Pressure on Variable-Rate Borrowers

Households carrying variable-rate debt such as credit cards and home equity lines of credit, or HELOCs, stand to feel the impact of the Federal Reserve’s interest-rate increase first.

The Wall Street Journal reported on September 16 that the Fed’s 0.25 percentage-point rate increase will also push up rates on financial products tied to short-term benchmarks. Charlie Wise, head of global research and consulting at TransUnion, estimated that a cardholder with the average $6,600 balance would pay about $1.38 more in interest each month.

The burden could rise even faster for HELOC borrowers. A HELOC is a variable-rate loan that allows homeowners to borrow within a limit backed by their home equity. Outstanding balances totaled $459.3 billion in the second quarter, and a 0.25 percentage-point increase in the prime rate could raise borrowers’ combined annual repayment costs by as much as $1.15 billion.

Mark Fleming, chief economist at First American, said homeowners are using home equity more than in the past to pay off other debt. Higher credit-card rates would add to that strain and could increase mortgage delinquencies.

The direct impact on mortgages and auto loans, by contrast, is likely to be relatively limited. Mortgage rates move more closely with yields on 10-year US Treasuries than with the Fed’s short-term policy rate. Auto loans are also influenced by longer-term market rates. Cox Automotive estimates that even if the full increase is passed through, monthly payments would rise by only about $6 for new vehicles and about $4 for used ones.

Homebuilders could face sharply different effects depending on how they finance themselves. Large builders that rely mainly on corporate bonds are more sensitive to long-term Treasury yields. Smaller builders and businesses that buy and resell homes depend more on short-term construction financing, making them more directly exposed to Fed rate increases. If mortgage rates also climb, the cost of offering subsidized mortgage rates to support home sales could rise as well.

Borrowing costs for companies and local governments have already priced in much of the expected increase. Average yields on investment-grade corporate bonds recently rose to 5.8% from about 5.4% a month earlier. If market expectations for further Fed hikes hold at current levels, corporate borrowing costs may not rise much further.

The broader market impact will depend on how many more times the Fed raises rates and on the direction of long-term Treasury yields. The effect of a single increase may be limited, but borrowing costs on credit cards and HELOCs accumulate with each hike. Depositors, meanwhile, could benefit from higher interest income depending on how much banks pass through the policy-rate increase to deposit rates.