Paycheck-to-Paycheck Consumers Won’t Find Budgetary Breathing Room From Rate Cuts

The initial euphoria that greeted the Federal Reserve’s decision this past week to cut interest rates for the first time in four years was keenly felt on Wall Street.

The Dow Jones Industrial Average, widely used as a proxy for investor sentiment, soared to new heights.

And while it’s true that the 0.5% cut to the Fed Funds rate — which is the benchmark for how all manner of debt, from credit cards to auto loans, is priced — will make borrowing more affordable relative to recent years, it will take time for the impact to trickle down to paycheck-to-paycheck consumers and households.

The eventuality that there may be some “breathing room” for these cash-strapped households will be welcome. But in the meantime, we may see some of the entrenched behaviors of the past few months — trading down, juggling merchants, pulling back on at least some discretionary expenses — remain entrenched.

Credit Card Debt Is Key

One key reason that the improvement might be scant (certainly over the near term) would be the credit card debt held by paycheck-to-paycheck households. Coming into 2024, we found that the majority of credit card debt — at about 60% — is and has been held by paycheck-to-paycheck consumers. Through 2023, we found in the “Credit Card Use Deep Dive” report, 65% of consumers struggling to pay bills, which represents roughly 20% of paycheck-to-paycheck households (a designation for more than 60% of households, as we’ve documented through the last several months) had hit their credit limits at least occasionally.

Roughly three-quarters of consumers earning less than $50,000 annually and two-thirds of consumers earning between $50,000 to $100,000 live paycheck to paycheck, so it is the folks who are not classified as “high earners” shouldering a lot of those monthly credit card obligations. Separately, PYMNTS data show that two-thirds of “financially unstable” consumers revolve their balances.

At present, per the central bank’s latest consumer credit data, the interest rates assessed on credit cards stood at more than 22.7% as of this past spring. That’s up starkly from the 17% seen before the pandemic. But higher risk results in higher assessed interest — nearly 30% for those cards held by borrowers with below super prime scores.

Repricing the Debt

The Fed Funds rate, after last week’s cuts, and which exists as a targeted range, stands at 4.75% to 5%. Most debt is “priced” at a premium charged over a “prime rate,” which as noted here is about 8%. Credit card debt is variable, which means it resets off of that prime rate, which can be in the double digits (hence the current rates north of 20%, as discussed above from the Fed’s data). The half “point” cut in interest rates could translate to only a commensurate half point “cut” in card interest rates — which translates to only a few dollars a month in savings. A consumer holding a $10,000 card balance with a 21% rate vs a $10,000 card balance with a 20.5% rate will “save” roughly $4 a month. The Fed’s rate-cutting campaign is likely to last well into 2025 but it will take time for the ripple effect of notably lower interest rates to truly take shape.

Past PYMNTS coverage shows that financially stressed, lower-income paycheck-to-paycheck households have $2,600, on average, in savings, which offers little breathing room to offset the other pressures of everyday essentials (such as shelter and food) that eat up nearly three-quarters of their take-home pay.  Inflation may be cooling but still lingers, and inflation had forced many consumers to change at least some of their spending habits, as they found incomes had not been keeping pace, so they’ve traded down or even cut spending in areas as diverse as travel-related spending or groceries.

The headlines on the Fed rate cuts promise relief — the reality may be a bit different.