Now may be the right time to slow down on credit card spending

Credit card debt is clearly causing restless nights after many consumers simply attacked higher prices for gas, groceries, and other goods by pulling out the plastic. Now, what do you do?

A record $1.13 trillion in debt ended up on credit card balances during the fourth quarter of 2023, according to the latest report on household debt from the Federal Reserve Bank of New York. Credit card balances increased by $50 billion or 4.6% during the quarter, which includes the holiday shopping season.

And some are struggling to pay bills on time. On an annualized basis, Fed data shows that about 8.5% of credit card balances became 30 days or more past due in the fourth quarter. About 6.3% of balances ended up in "serious delinquency" status, meaning the bill was at least 90 days late.

One has to go back to 2011 to find the last time, based on the Fed data, that serious delinquency rates were higher.

Rising credit card debt, and high rates, have some concerned

Is it time to panic? No, probably not. Many economists remain optimistic about the overall financial health of many, but not all, households. After all, the jobs picture is strong and many people aren't facing massive layoffs. Bonuses, wage gains, and opportunities to switch jobs for higher pay remain part of the landscape.

Is it time to slow down on spending? Probably, yes. Some households that took on a great deal of credit card debt may want to tap the brakes here to gradually improve their finances and be ready to take better advantage of lower interest rates in the next year or so.

For many, it will make a great deal of sense to put some money toward paying off high-cost credit card debt in 2024, say by using money from a substantial income tax refund or profit-sharing check from Ford Motor Co., General Motors or Stellantis.

Some 700,000 households in Michigan will benefit from a far more generous Michigan earned income tax credit for working families. On Wednesday, the Michigan Treasury started rolling out these extra supplemental checks based on 2022 returns.

The checks will provide eligible taxpayers with an average of $618 for the 2022 tax year. Some will receive that money in February, others in March.

Any extra cash could be used toward paying off some credit card debt.

The problem is that high interest rates continue to hurt those who carry credit card debt. Credit card balances grow rapidly, thanks to interest rates in the 20% range.

Consider this example: If you only make minimum payments toward $6,360 in credit card debt at an annual rate of 20.75%, you'd be in debt for 218 months — or a bit more than 18 years — and will end up paying $9,542 in interest, according to Ted Rossman, senior industry analyst for CreditCards.com and Bankrate.com.

Paying down debt also might help improve your credit score and open up doors for better interest rate offers later in 2024 and 2025, as the Federal Reserve moves to cut rates, said Michele Raneri, vice president and head of U.S. research and consulting at TransUnion.

Raneri said consumers who opt to consolidate or refinance high cost credit card debt could qualify for better rates if they have improved credit scores.

Interest rates on credit cards would trend down gradually, as the Fed cuts interest rates several times in the next few years. It can take a few weeks, experts say, but Fed actions generally filter through directly to consumers' credit card rates.

Why you want to think about your credit score now

Your credit score can matter even more if you're likely to shop around for even better rates.

TransUnion's Raneri said consumers can take real steps now that can help them in the next six months to nine months or so.

Younger consumers, in particular, can benefit even more quickly by knuckling down on their spending and putting more money toward reducing their credit card balances, according to Raneri. Their credit history is relatively new and can more easily change to reflect improvements.

"I know delayed gratification is hard," Raneri said. "It's hard to say no to friends if they're going on a trip. It's hard to do that."

She said consumers should work to improve their credit scores now where possible.

Taking serious steps to improve your credit picture will ensure that you're well-positioned to take advantage of those lower rates if the opportunity arises, Raneri said.

A better credit score could mean that you might get better offers for credit cards down the line or better rates to refinance debt, as interest rates fall in the months ahead.

"Don't take out a lot of new credit, if you don't need it," Raneri said. "You don't want to have a lot of new credit coming on."

Credit scores can fall, temporarily at least, when you take on new credit, and taking out more than one new loan would impact a score.

Strategies to boost your credit score include: Paying all bills on time; never missing payments. Putting more money toward paying down credit card balances. Keeping a low credit card balance. Avoiding opening new credit cards or taking on new loans.

"The longer you pay your bills on time after being late, the more your FICO Scores should increase," according to a tip sheet from FICO on how to improve your credit score.

Another FICO tip: "Don't close unused credit cards as a short-term strategy to raise your scores."

Pay attention to how big of a balance you're carrying on each credit card. You might think that your credit score is in good shape if you have a $2,000 line of credit on a credit card and you're carrying a balance of $1,200.

Quite the opposite. Your credit score will be hurt if you're charging 40% or 50% or more of your available line of credit. If you're able to keep a balance of 30% or less of your credit line on each credit card, you're in far better shape.

Check your credit report, too, to make sure that there aren't any errors. See www.annualcreditreport.com for free weekly online credit reports from TransUnion, Equifax, and Experian.

Average credit card balances per consumer, according to TransUnion, hit an all-time high of $6,360 in the fourth quarter last year. That was up 10% year over year.

The average balance, though, includes debt that consumers roll over from month to month, as well as balances that are paid in full each month.

While there has been an alarming increase in credit card balances, some 51% of card holders typically pay their credit card bills in full each month based on Bankrate.com data.

"These are the people benefiting from rewards, buyer protections, and not paying interest," Rossman said.

Even so, Rossman noted that more people paid off their balances in full during the pandemic when credit card spending was lower. In 2021, he said, 61% of credit card holders typically paid their credit card balances in full each month. "So, we're moving in the wrong direction," Rossman said.

How much financial stress people are facing now depends a great deal on the individual household. If someone is facing a potential layoff, it's far more worrisome than if they've just taken on a new job at higher pay.

"Banks don't seem too concerned about the macro picture," Rossman said. "But at the individual level, we are starting to see more cracks emerge and hearing more about people falling behind, sadly."

What's the outlook for interest rates?

Mark Zandi, chief economist for Moody's, said delinquency rates have risen from their depressed pandemic lows, and are currently just above where they were prior to the pandemic.

Even so, he believes that delinquency rates and credit problems have peaked at this point as of early in 2024.

Zandi takes issue with how the New York Federal Reserve calculates delinquency data, which he says overstates the credit problems facing most households.

Based on credit files nationwide from credit bureau Equifax, he said, delinquencies actually have stabilized in recent months.

In addition, he said, lenders tightened their underwriting standards in the wake of last year's banking crisis, which has significantly slowed the growth in debt overall.

Many low-income households, Zandi said, turned to credit cards and consumer finance loans to supplement their incomes and maintain their spending power as inflation surged in 2022.

Fortunately, he said, inflation has been moderating for more than a year, and these households are no longer borrowing as aggressively.

How quickly interest rates fall is anyone's guess. The same's true for the inflation outlook.

The consumer price index — a key inflation barometer — hit a 9.1% pandemic-era peak in June 2022 — the highest level in 40 years. Inflation has cooled since then.

The consumer price index increased 3.1% over the last 12 months in January, according to data released Tuesday by U.S. Bureau of Labor Statistics, which was down from the 3.4% in December.

But economists expressed concern about the month-to-month increase of 0.3% in January, which was slightly bigger than expected and higher than the December monthly increase of 0.2%.

While energy prices fell in January, the price of food bought at grocery stores and bought in restaurants went up. Shelter showed a significant increase month-over-month in January.

Inflation remains worrisome, but many economists expect that the Federal Reserve will begin cutting interest rates on May 1 or possibly wait until a meeting scheduled for June 11 and June 12.

Currently, many economists expect the Fed to hold steady at the next meeting March 19 and March 20.

As inflation pulls closer to the Fed's 2% target range, economists say the Fed has more room to cut interest rates, which should help borrowers in the future.

Most economists, including Zandi, expect interest rates to fall fairly significantly in 2024 and 2025.

Zandi is forecasting that the Federal Reserve will cut short-term interest rates four times in 2024 — a quarter-point each time. He expects another four rate cuts in 2025 and two more in 2026.

Ultimately, Zandi expects the short-term federal funds rate to hit 3% in 2026.

As of now, the federal funds rate sits at a target range that runs between 5.25% and 5.5%.

One rate cut won't be a magical fix. The Fed had raised short term rates 11 times starting in March 2022 and ending with the most recent rate hike in July.

Following the Fed's string of rate hikes in its fight against inflation, the average credit card rate gradually moved to hit a record high of an annualized rate of 20.75%, according to data from Bankrate.com.

Last year at this time, the average credit card rate was 19.93%. The average credit card rate was 16.34% in March 2022.

"So, if the Fed cuts the federal funds rate by a quarter-point," Rossman said, "your credit card rate should fall by a quarter-point within a few weeks. This affects new and existing balances, by the way."

Dealing with all that credit card debt will be a tough slog. But forecasts for lower interest rates ahead give consumers more reason to buckle down and get to work.

Contact personal finance columnist Susan Tompor: [email protected]. Follow her on X (Twitter) @tompor.