The Feds raise rates again; What does that mean for you? (6/30/06)

The Federal Reserve Board raised rates for the 17th straight time. Before I go into how this may affect you directly, I'll refresh your memory on how this works. The Federal Reserve Board controls monetary policy in the United States. They have a number of "economic indicators" that help them make decisions regarding monetary policy. The unemployment rate, the GDP, and consumer confidence index are examples of these economic indicators. The Federal Reserve Board is lead by the Chairman Ben Bernanke.

The key interest rate they are referring to is the Fed Funds rate. This is the rate that the Federal Reserve Bank charges member banks to borrow money. When the Fed charges banks more, banks in turn charge you more. The primary rate effected by the Fed Funds rate is the Prime Rate. Most credit cards, home equity loans, and short term loans (less than 1 year), are based on the Prime Rate.

Now, how does this affect you directly?
The Prime Rate today is now 8.25%. Most credit cards are tied to the Prime Rate, such as Prime + 4%. The Prime Rate on July 1, 2005 was 6.25% and on July 1, 2004, it was 4.25%. If you carry a balance of $3,000 on a credit card with an interest rate of Prime + 4%, you would have accrued approximately $21 in finance charges each month in July 2004. Today, you would accrue about $31 in finance charges. That's an increase of almost 50%. If you're carrying a balance of $10,000, that's a finance charge of over $100 a month if your rate is Prime + 4.

Credit card debt is never good to have, but it's even worse when you're getting slammed by rising interest rates. If you fail to increase the amount of money you pay to your credit cards each month, you'll only be digging a deeper hole for yourself to climb out of. It's imperative that you re-allocate your disposable income to decreasing your credit card debt.

Here's a few tips for reducing credit card debt:
1. Make a budget. Write down your net income and expenses on a sheet of paper. Putting these items on paper will give you greater organization. Remember, out of sight, out of mind.
2. Reduce your "luxury" expenses. Evaluate your "wants" vs. "needs". You'd be surprised how many "needs" are actually "wants". If you're having trouble with this, here are some examples of "wants": cell phone, cable TV, dining out, etc. Allocate those funds to your credit card debt.
3. If you've done all of the above and you still don't see any light at the end of tunnell, get a second (or third) job.

Keep in mind, getting out of debt is a simple equation: spend less than you earn. It's much tougher to implement after years of spending more than you earn. It could take years to climb out of debt depending on how much debt you have and how much you earn. Don't be discouraged if you can't eliminate your debt quickly. Most people can't. Debt consolidation loans are only temporary bandaids. The equation (spend less than you earn) is the only way to eliminate debt. Just like diet and exercise are the only ways to lose weight. Pills and Lypo are only temporary.

Please feel free to contact me if you have additional questions regarding this topic. As always, everything I discuss with you will be kept confidential. I'm going to write another blog entry shortly regarding extreme measures of trying to get out from under credit card debt.