Interest rates are an important factor to consider when buying expensive items with a line of credit, applying for a loan, or just using any credit card. In general, those with higher credit scores tend to qualify for a better interest rate than those with lower credit scores. The following are six things consumers should know about their annual percentage rates or APR.
1. Credit cards typically have more than one interest rate. One credit card will likely have an interest rate for new purchases, an introductory rate that lasts for a limited time (maybe 6 months), a balance transfer rate, which may also include an introductory rate and a regular rate, plus a cash advance rate and a higher rate that kicks in if the cardholder defaults on payments. Consumers should never assume that there is only one interest rate on a card, even if one rate is most prominent on card materials. It’s important to compare all of the different rates when comparison shopping for credit cards.
In order to avoid paying interest on a credit card, the statement balance must be paid off by or before the due date. Minimum payments typically include all the interest charged on the balance for that month as well as some principal. With a higher balance and a relatively low minimum payment, the majority of the payment is going towards interest. For example, a credit card carrying a balance of around $5,000 with a relatively low minimum payment of $150, close to $100 of that payment will be going to interest depending on the rate. To avoid paying more interest, it’s important that consumers keep an eye on their minimum payments.
2. The majority of interest rates are variable. This means that they fluctuate according to the prime rate. If that rate goes up, then the credit card or loan rate may also go up. The only exception to this is usually introductory rates, which are almost always 0%, but are usually fixed until the time limit runs out.
3. The purchase APR of any given credit card is based on the consumer’s credit score. This is one of many reasons why good credit scores are so important to have and keep track of. A higher credit score will usually mean a lower risk to the lender, which then translates to a lower interest rate. When comparison shopping for a credit card, consumers should find their credit scores in advance to get an idea what type of rate they might be dealing with.
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4. Credit card interest rates can go up for various reasons. A prime rate increase is only one of the reasons that an interest rate might go up. When a consumer goes 60 days or more without paying or not making minimum payments, then a penalty interest rate usually goes into effect. Along with any applicable late fees, the penalty interest rate can be extremely high, thus drastically increasing the amount the consumer will owe on their balance.
A lender may also simply increase the existing rate for no apparent reason, but in this case, the consumer can refuse to pay the new rate and close their card. They will then pay the original rate on the remainder of their balance. Usually, the bank will enforce the new rate only if the customer decides to keep their account open.
5. It’s possible to negotiate a credit card interest rate. Consumers who are unhappy with their current rates can call the lender and ask for it to be reduced. They may not always be willing to do this, but in many cases they are. The truth is that consumers rarely call as they assume that the bank won’t be willing to help. Another quick way to get away from a high rate is to take advantage of a zero percent balance transfer option. Though that may not be as readily available to those with low credit scores due to delinquency or a high amount of debt.
6. It varies by the lender on how you are charged interest each month. Usually, lenders will give consumers who make a purchase 21 days “interest-free” or what is also known as a “grace period”. If you pay your new balance in full by your payment due date, you will avoid any interest. If you don’t pay your balance in full, you will then pay interest on each new purchase from the transaction date until the payment date. Your next statement will continue to carry over the interest accrued on each new purchase.
The interest calculated on credit cards can be troubling and confusing. Carrying balances over each month will lead to a larger balance, with you paying more than the original amount owed. This is due to the credit card interest calculated each month on the remaining balance. There could also be other fees, such as over-the-limit fees, late payment fees, returned checks, membership fees, annual fees, etc. Now your balance is much higher than the original amount the card was used for.
To calculate the interest correctly, the lender will add the amount you owe each day, divided by the total number of days in that statement period which could vary from month to month. That amount will be your daily balance. Then, the lender will multiply the average daily balance by the daily interest rate you’ve been given. The daily interest rate is the annual interest rate divided by 365 days multiplied by the number of days in that statement period. This is how the interest is calculated.
Fixed interest rates are always the best option since the rate does not change without prior notification and sufficient time allowed for making the necessary adjustments. Your fixed rate cannot be changed without proper notice and there are laws protecting the consumer from this. This may make you feel more comfortable, but credit card companies are a little tricky in how they inform you of these changes. An example is putting it in the fine print on your monthly statement indicating the rate change. It’s usually written so small that you can easily miss it.
The best advice on using credit cards is to pay off your balance in full each month by the due date. You avoid paying high-interest rates and have the option to cancel the card or not use it should the rate be drastically increased. Be informed on the types of credit cards available and ALL of their interest rates to make the right decision on what card to choose. Read the fine print and understand that your APR might be variable and could increase at any point in time.