Credit card interest rates are discussed very often. It can be argued that they’re one of the most important features of a credit card. Your credit card’s interest rate affects how much you pay for carrying a credit card balance.
What is an interest rate?
The interest rate is most often stated as an annual percentage rate. This is the annual cost of carrying a balance on your credit card. Since credit card interest is charged on a monthly basis, credit card companies typically use a periodic interest rate which is just your APR divided by the number of billing periods in the year. For example, if your APR is 12% and you are billed 12 times a year, your periodic interest rate is 1% (12 divided by 12).
How does the interest rate affect my credit card?
Your interest rate, or APR, comes into play when you carry a credit card balance beyond the grace period. The grace period is the amount of time you have to pay off a credit card balance without receiving interest charges. Grace periods are typically 21 days.
When you carry a credit card balance, your balance is multiplied by your periodic rate to come up with your finance charge – that’s the monthly interest charge you pay. The higher your interest rate, the higher your finance charges will be.
Types of Interest Rates
There are several different types of interest rates. We’ve already discussed the annual percentage rate and the periodic rate. There are more.
Variable vs. fixed interest rate
A fixed interest rate is an interest rate that doesn’t (easily) fluctuate over time. Fixed credit card interest rates are allowed to increase, but only under circumstances and you must be notified before the interest rate increases.
A variable interest rate can fluctuate and your credit card issuer doesn’t have to let you know when your variable rate is increasing. Variable interest rates are typically tied to another interest rate, most often the national prime rate as published by the Wall Street Journal. If your credit card has a variable interest rate it’s typically stated something like “16.74% plus prime.”
The purchase interest rate is the interest rate applied to purchases you make on your credit card. Depending on how you use your credit card, it may be the only interest rate you ever have to deal with.
The cash advance interest rate is the interest rate applied to cash advances – cash withdrawals made against your credit card balance. Cash advances don’t have a grace period and interest starts being added right away.
The balance transfer interest rate is the interest rate that’s applied to a balance transfer. You may receive a promotional balance transfer interest rate. These promotional rates are often low, i.e. less than 5%, and last anywhere from 3 months to 12 months.
The default or penalty interest rate is the interest rate you get charged for defaulting on your credit card terms. Default includes things like making a late credit card payment or going over your credit limit.
How payments are applied to balances with different interest rates
This is how things are done now:
When you have different balances with different interest rates on a single credit card, any payment above the minimum does toward the balance with the lowest interest rate. No payments are applied to the balances with higher interest rates, so they continue to accumulate finance charges until the lower interest rate balance is completely repaid.
How things will be next February:
New rules go into effect February 22, 2010 that will change the way payments are applied to balances with different interest rates. Card issuers will be required to put any payment above the minimum toward the balance with the higher interest rate. This saves you money in the long run.
What causes credit scores to go up?
Your credit score could rise for a number of reasons. It could be something you did or it could have been the credit card company’s way of trying to make more money.
You could cause your interest rate to increase because you:
- Paid late on your credit card
- Maxed out your credit card balance
- Wrote a bad check for your credit card payment
- Didn’t abide by the credit card terms
- Used your credit card illegally
What to do when interest rates go up
If your credit card interest rate goes up, the credit card issuer is required to give you at least 45 days advance notice. During that 45-day period, you have the right to reject the new credit card interest rate. If you reject the new rate, you’ll have the chance to pay off your balance at your older, lower interest. However, you’ll be required to close your credit card. Before you opt-out of the new rate, make sure you’re really ready to lose the credit card.
Credit card issuers don’t have to give advance notice if they’re increasing your interest rate because you defaulted on your credit card. If it’s your first late payment, your lender may be lenient and lower your interest rate. Otherwise, after six months of timely credit card payments contact your lender and request your old rate. Starting February 22, 2010, your lender has to lower your rate after six months of timely payments.
Don't forget to let me send you future guides and tutorials. Just subscribe to the RSS feed, or just enter your email below; I'll make sure the updates are emailed to you.
