The Credit Card Interest Rate Tutorial
Ask the average person what the credit card interest rate is on their credit card, and chances are, they won’t know. Despite the fact that credit cards are increasingly the accepted way to pay for things, the typical user has no idea about his or her credit card interest rate. They don’t even know that on any one of their credit cards, there are different credit card interest rates for the different reasons they use their credit card. At least once a year, every credit card owner should take an hour or two to analyze their credit card statements to understand their credit card interest rates. If they have more than one credit card, they should take their credit card statements and compare their credit card interest rates for each card during their annual analysis. They will be amazed at the differences in the credit card interest rates within and among their credit cards. In effect, your credit card billing statement is your basic text book for your course in “Credit Card Interest Rates – 101” – and your reading should include every word – including the small print and the print in light grey color.
Lets start our course in credit card interest rates by understanding some of the terms used when talking about credit card interest. We begin with the four basic kinds of credit card interest rates: Standard, Introductory, Cash Advance, Default credit card interest rates.
A Standard Interest Rate is the most commonly used credit card interest rate and it generally applies to the daily purchases you make, such as groceries, gas, restaurants, mall purchases, etc. It is sometimes referred to as the “Purchase Interest Rate” when talking about credit card interest rates. It is usually charged to the majority of a balance on a typical credit card.
The next term used to identify a particular type of credit card interest rate is “Introductory Interest Rate.” These are marketing tools used by credit card companies competing for your credit card business. These are short term credit card interest rates used in this highly competitive industry to attract customers. In some cases they can be as low as zero percent. “Short term” is the operative word here, because these introductory credit card interest rates last anywhere from 6 to 12 months, and in some cases as long as 15 to 18 months. Just remember, all good things come to an end, and you should be aware of the risk associated with introductory credit card interest rates.
The third rate to be aware of is the “Cash Advance Interest Rate”. On your same credit card, you will be charged two different credit card interest rates, depending on how you use your credit card – the standard rate and the cash advance rate. In most cases, the cash advance interest rate will be the highest non-default credit card interest rate on the account. You should be aware that cash advances have many disguises, like cash back when you buy your groceries, when you wire money transfers and basic ATM withdrawals. All of these are the faces of cash advances when it comes to calculating your credit card interest rates.
Finally, the most threatening of all credit card interest rates is the one called the “Default Interest Rate,” also known as the late payment or missed payment interest rate. It is also the credit card interest rate calculated when you spend more than your credit limit allows. You really don’t want to ever be charged the default credit rate, because it is extraordinarily high.
Understanding these four types of credit card interest rates should lead you to several important conclusions. One is to first be aware of the factors that enter into credit card interest rates. The second conclusion is to never use your credit card as a debit card unless you really have to avoid a negative impact of credit card interest rates. A third caution is to always pay your credit card bill on time. Finally, wherever possible, you should pay more than the minimum payment. Using these caveats will all you to maintain personal control over your credit card interest rates, and not the reverse.
A corollary to this knowledge is also to be aware that when you pay your monthly bill, your payments go towards the lowest interest rates first, then to the highest interest. Thus, when calculating your credit card interest rates, if you have incurred numerous cash advances on the account, or late payments, your minimum payment is only chipping away at the standard credit card interest rate, while the higher rates you accumulated are multiplying the interest that keeps your balance growing. Financial advisors suggest sending more than your minimum payment to deal with this issue, because the extra payment will be allocated to the higher credit card interest rate balance.
While on this topic, let’s take a look at how your credit card interest rate is determined. This brings us to two more special terms in the world of credit card interest rates: a fixed rate or a variable rate. In the credit card interest rate glossary, “fixed rate” is also known as fixed APR.
A fixed rate, as the name implies, is a credit card interest rate that will not change until a decision is made by the lender to change it. Don’t be fooled, however, by marketing that says the rate is “fixed for life”. In reality, a lender has the legal right to change it anytime (but seldom do). Financial advisers suggest that you should consider a fixed rate card when interest rates are on the rise.
A variable rate is tied to a certain index, (like the prime rate or T-Bills) and varies depending on what way the index goes. In contrast to a fixed rate card, when interest rates are on the way down, a card with a variable credit card interest rate makes the most sense. As you can see, there are many variables when dealing with credit card interest rates, and you should take your time in selecting the right one for you.
During your analysis, consider four other terms, one of which describes how your credit card company compounds your credit card interest rate: daily balance, adjusted balance, previous balance and ending balance. Credit card interest rates are calculated differently by different credit card companies. You may have to visit the internet for Credit Card Interest Rates – 102 for a more detailed analysis of these terms. For the present, however, it should be enough to understand that most credit card companies commonly calculated the credit card interest rate on the average daily balance on your account. The average daily balance is calculated by adding the monthly daily balance and then dividing this number by the number of days in the month. By the way, the most recent average credit card Annual Percentage Rate was 15% according to a 2012 weekly credit card interest rate report.
Another basic term that a student of Credit Card Interest Rates – 101 should be aware of is “Grace Period.” The grace period is the amount of time the consumer has from the date of purchase to the date where the first credit card interest payments will be changed. Grace periods are generally 30 days. After the grace period, interest will be charged on a daily basis. The “daily basis” is calculated by dividing your annual interest rate by 365 days and charged on a daily basis. This means that the first day after the grace period, you will pay interest on your balance. The day after that, you will pay interest on the balance and the interest. The moral of this story in the credit card interest rate saga is that to escape high interest, you should pay off your credit cards in the grace period.
Here’s another term from the glossary of credit card interest rates: “credit card utilization ratio” This is the amount of your available credit that you’ve used. Financial advisers indicate that you are in great shape if your utilization is 10 percent or lower. When you go over 30 percent, you risk a credit-score drop. Your credit card utilization ratio definitely affects your credit card score, so in addition to knowing all you can about credit card interest rates, you should pay attention to your credit card utilization ratio.
The first time you read the small print on the back of your credit card statement, you can be excused for being somewhat dazed by the legal mumbo jumbo about credit card interest rates. However, the information is there for your protection – and the transparency which has been mandated in recent years makes navigating the shark-filled waters of credit card interest rate knowledge a bit easier than it was for previous generations. However, it places a burden on the consumers to educate themselves regarding credit cards and credit card interest rates. This brief introduction to the basic terminology in Credit Card Interest Rates-101 should motivate you to further in-depth research on credit card interest rates on the internet.