Your Unreliable Friend: Variable Rates


The days of cheap borrowing are beginning to fade. Last week, the Federal Reserve raised short-term interest rates by a quarter point, ending several years of rate-slashing.

Rates still remain low by historical standards, but the promise of future rate increases means that variable interest rates are losing some appeal. So this is a good time to make sure you understand the rates and terms on your credit cards, home-equity line of credit and mortgage, and what higher rates might mean to you.

Credit cards

Credit-card companies are likely to waste no time in passing on the pain of higher rates to consumers. One reason: Many card agreements let issuers base rates for variable-rate cards on the highest prime lending rate during the preceding 90 days.

"If you have a variable-rate card, you will see the increase and you will see it quickly," says Robert McKinley, chief executive of "Some will show up as early as July, others in August."

Overall, credit-card rates are likely to climb 0.19 percentage point within two months, he says, and by nearly a full percentage point within nine months if the Fed continues to raise rates as expected. Rates on variable-rate cards currently average 13.5%, while fixed-rate cards average 12.8%, according to

The rate increases could prove especially painful for borrowers who have exceeded the credit limit on their card or are late on a payment to any creditor. Even before the rate increase, some card issuers including Citibank charged punitive rates above 27%. Lenders could also boost late fees and other charges if rapid rate increases pinch profits, Mr. McKinley says.

Even borrowers with fixed-rate cards could wind up paying more down the road. In a recent filing with the Securities and Exchange Commission, MBNA Corp. said there is typically a lag of 45 days between interest-rate movements and repricings of its fixed-rate credit cards. "If the Fed adjusts its rates, we'll probably raise our rates accordingly," an MBNA spokesman says.

Home-equity lines of credit

Rates on home-equity lines of credit typically move in tandem with the prime rate. So people who hold these loans will soon be forking over more in interest. Just how quickly the higher rates will show up in borrowers' statements depends on the lender.

Wells Fargo & Co., for example, takes about a month to pass on a rate increase to existing customers, meaning that last week's increase will show up in the July or August statements, depending on a customer's billing cycle. New customers will be hit with the higher rate right away.

The increase shouldn't be too heavy of a burden for most borrowers, even if the Fed raises rates several times over the next 12 months, as expected. That's because the typical credit line is just $25,000 to $30,000. If, for instance, rates jump to 6%, someone who borrowed $30,000 using a 15-year home-equity line might see their payments increase by about $31 a month.

Even with the higher rates, home-equity lines remain a good deal for many borrowers. Some lenders currently offer starting rates of one-quarter or one-half percentage point below the prime rate. That means borrowers can start out paying 4% or less, even after last week's rise in rates. The fixed rate on home-equity loans, meanwhile, now averages 7.05%, according to HSH Associates.

"If your repayment period is less than three years, the line of credit is still attractive," says Greg McBride, a senior analyst with Someone who will need the money for longer than three years should consider locking in a fixed-rate home-equity loan, he adds.


Higher rates won't mean higher costs for homeowners with fixed-rate loans. But they could eventually bite homeowners with adjustable-rate mortgages. ARMs account for about 40% of prime mortgage debt outstanding, according to Fitch Ratings, and are particularly popular in areas where home prices have skyrocketed.

But some ARMs are riskier than others. For instance, hybrid ARMs typically carry a fixed rate for the first three, five, seven or 10 years. Depending on what happens with rates over time, by the time you hit the adjustment period some of the worst pain from higher rates may be over. Borrowers who opt for ARMs that adjust more frequently, on the other hand, may already be feeling the sting from higher rates. ARMs that adjust more often than once a year are typically tied to the London Interbank Offered Rate, or Libor, which has increased by 1.13 percentage points since March.

Anyone shopping for a new mortgage has already felt the impact of rising rates. Rates on 30-year fixed-rate mortgages have climbed to an average of 6.22% from this spring's low of 5.53%, according to HSH Associates. They could reach as much as 6.75% by year end and climb above 7% in 2005, according to Doug Duncan, chief economist of the Mortgage Bankers Association. Rates on ARMs may move up by an equal amount, Mr. Duncan says, assuming the Fed raises rates by a quarter-point twice more this year.



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