A 1-Point APR Hike Triggers an 8.7% Spending Drop; Are Issuers Killing Interchange Revenue?

People rein in their credit card spending when the annual percentage rate on their card account goes up, according to a new study from the Federal Reserve Bank of Boston. 

The report from the Boston Fed shines a light on how monetary policy can influence consumer financial behavior and provides actionable data on how adjusting rates on cards can affect different cardholders.

Many people may not consider the connection between the Federal Reserve and the interest rates on credit cards consumers and businesses use. But the Boston Fed indicated in its report that the variable rates most credit cards come with often go up or down when the Federal Reserve makes changes that affect the federal funds rate.

The decisions the Federal Reserve makes in regard to interest rates thus carry major implications for the overall spending levels of U.S. consumers.

The report reveals that close to 20% of all U.S. consumer spending came from credit cards in 2022.

The Boston Fed study indicates that U.S. consumers used their credit cards to make purchases totaling more than $5.8 trillion in 2022. That figure corresponds to approximately 20% of the entire amount of consumer spending for the year.

And the report’s findings reveal that cardholders react to even small increases to their rates on their credit cards by keeping those cards tucked away in their wallets more often.

“Our analysis finds that when credit card interest rates increase by one percentage point, consumers reduce their credit card spending by 8.7% in the following month,” Falk Bräuning, Vice President and Economist at the Federal Reserve Bank of Boston, and Joanna Stavins, a former Principal Economist and Policy Advisor with the Boston Fed, wrote in the report.

The Federal Reserve Bank of Boston released its new study at a time when lawmakers are paying close attention to credit card interest rates. Earlier this year, President Donald Trump gave his approval for capping card interest rates at 10%. 

Other politicians were quick to throw their support behind Trump in his call for a cap. But the new report from the Boston Fed shows just how sensitive cardholders can be to rate fluctuations.

Credit card issuers can use the Boston Fed data to inform their strategies to grow revenue. For starters, the report shows that issuers should examine how their cardholders may respond before raising rates to increase revenue.

Higher rates could lead to more interest income for issuers if cardholders continue to keep the same balances on their accounts from one month to the next. But the 8.7% drop in spending that immediately follows a 1% rate increase would likely put a significant dent in the interchange revenue.

And issuers could also eventually see less income from interest even if they raise rates. The Boston Fed said that a one percentage point increase in the APR on a card leads to a 4% drop in its revolving balance. 

Every cardholder — and every credit card issuer’s card portfolio — is different. Credit card companies should take a close look at cardholder behavior in relation to past rate changes to better understand how cardholders will react to future adjustments. 

The Boston Fed highlighted that those who pay their card balances in full each month respond differently to rate changes than those who regularly revolve their account balances.

“For accounts that carry balances, a one percentage point increase in the APR reduces spending by about 15% in the following month, or nearly double the overall average effect,” Bräuning and Stavins wrote. “By contrast, the credit card spending of transactors does not respond significantly to interest rate changes.”