As of May 2018, the Federal Reserve estimated that Americans had nearly $1.04 trillion in revolving credit, the majority of which was credit card debt. That daunting amount of money doesn’t reflect the average amount of debt each individual carries, but most of us have at least one credit card in our wallet: At the end of 2017 there were 364 million open credit card accounts in the U.S. For anyone who’s a cardholder, the more you understand about credit cards and their costs, the better off you will be.
Interest Rates and APR
The annual percentage rate (APR) is what a financial institution charges each customer on a loan or a credit card balance. Some credit card companies offer a low introductory rate for new customers and on balance transfers for six months or one year, and others charge different APRs depending on how the credit card is used. Credit card companies usually charge a higher APR on cash advances, for example, than on purchases. Your interest rate is set by the credit card company and may be based on your credit score.
Fixed Rates vs. Variable Rates
Credit cards will have either a variable APR or a fixed APR. If you have a fixed rate credit card, the interest rate might still change if you pay your bill late or not at all, or if the credit card company sends you a written notice of a rate increase. Variable APRs are normally tied to the prime rate, which is the interest rate banks charge to corporations. The prime rate usually adjusts when the Federal Reserve adjusts the federal funds rate. When you read the fine print on your credit card agreement, you will usually see a statement with your rate reading as “Prime rate plus 8%” or something along those lines.
When Interest Is Charged
Credit card companies begin charging interest after a balance is outstanding for one or more billing cycles. If you want to avoid paying interest, you need to pay your credit card balance in full before the due date each month. One other option is to put charges on a zero-interest credit card, but that’s a temporary fix: Zero-interest promotional rates usually last for only six months to a year. And unless you pay off the entire balance by the last day of the promotional period, you can be hit with retroactive interest charges for the whole balance.
Why Your Interest Rate Changes
Most credit card companies charge one rate for a purchase, another for a balance transfer and another for a cash advance. In addition, you may be charged a default or penalty rate if you are 60 days late paying your existing balance. If you go over your credit limit or are 30 days past due on your bill, the default APR will be charged on future transactions. The other reason your rate could change is that you signed up for the card at a lower introductory interest rate and that introductory period has expired.
Changes to Your Interest Payments
Be particularly conscious of the interest rate you are being charged by your credit card companies because the rate has a dramatic impact on the amount of interest you pay each month on your debt. If, for example, you have a credit card with a balance of $2,000 at 18% interest and you pay $50 per month toward that balance, it will take 62 months to pay it off – and the total, including more than $1,000 of interest, will come to $3,100. If you transfer that balance to a credit card with a 9% interest rate and make the same $50 monthly payment, you will pay a total of $2,400, including interest, and it will have taken just 48 months.
Many consumers opt to transfer balances to a lower interest rate or even a zero-interest rate if they can. One caution: Most credit card companies limit these low-interest periods and charge a balance transfer fee of 3-5%. Make the calculation to determine if the amount you are saving on interest payments will be enough to offset any balance transfer fee. (Find a debt repayment calculator here.) If the goal is to pay off your credit card debt within the zero-interest time frame, make sure tocalculate how much you need to pay each month to reduce your balance to zero before the introductory rate expires.
The Bottom Line
The best way to make sure you pay the lowest interest rate on a credit card balance is to keep your credit score high. Credit card companies typically offer their best rates to the most creditworthy customers. If your score has improved since you got the card, don’t be afraid to call your credit card company and ask them if they’ll lower the rate. Often, they will be willing to work with you to keep a loyal customer.