As inflation raises the cost of living, consumers are trying to keep up by putting more purchases on credit cards and allowing balances to grow. That is a cause of concern at the Federal Reserve, which is trying to fight inflation by raising interest rates.
In a new report, the Federal Reserve Bank of New York found credit card balances increased by $38 billion from the second quarter of last year to the third quarter. That coincides with sharp increases in the Consumer Price Index (CPI).
The Fed has two concerns. First, it would rather consumers spend less on products and services to help lower inflation. But a second concern is that, as high-interest credit card balances swell, fewer consumers will be able to make timely payments.
The Fed data doesn’t show which consumers pay off their credit cards in full each month and those who let their balances grow. However, the data does show the younger the consumers, the more debt they had in the third quarter.
Can consumers continue to make payments?
“The real test, of course, will be to follow whether these borrowers will be able to continue to make the payments on their credit cards,” the authors wrote.
In August, LendingClub Corporation, in partnership with PYMNTS.com, released its periodic study of consumer spending patterns and found that 61% of consumers spend all of their money between pay periods. That was up from 52% a year ago.
That makes living paycheck-to-paycheck the most common financial lifestyle in the U.S., with increasingly more high-income consumers now entering that category. Some, an estimated 13%, actually spent more than they earned in the previous six months by tapping savings or going into debt.
That presents a huge problem when prices of nearly everything are rising. It isn’t possible to keep up that kind of spending without an increase in income or an increase in debt.
Balance transfer or personal loan?
To reduce credit card debt, some consumers who can qualify for a balance transfer credit card might consider opening an account that offers a year or more of 0% interest. Another alternative is to take out a three-year fixed-rate personal loan and use the money to pay off a high-interest credit card.
The average interest rate on a credit card is approaching 21% but some are much higher. According to NASDAQ, the average interest rate on a three-year personal loan is less than 13%.
The payments may be higher but you get out of debt faster. A five-year loan might offer lower payments but carries a significantly higher interest rate.
A personal loan may also be a good choice if you need to pay off a large balance because it offers a fixed interest rate. Credit card rates will rise each time the Fed hikes interest rates.