Credit card interest rates can be confusing and intimidating for many consumers. It’s essential to understand what they are and how they work to avoid falling into credit card debt. In this article, we’ll take a closer look at credit card interest rates, the different types, how they are calculated, and the factors that affect them.
Credit card interest rates are the rates that lenders charge you for borrowing money from your credit card. When you carry a balance on your credit card, you accrue interest charges based on the interest rate charged by your card issuer. These charges are added to your outstanding balance, making it more difficult to pay off your debt.
Types of Credit Card Interest Rates
There are different types of interest rates that credit card issuers can charge you, including:
Purchase APR
The purchase APR is the interest rate charged on the purchases you make using your credit card. This interest rate is often the lowest of all interest rates charged by the card issuer.
An example of a credit card that offers low purchase APR is the Scotiabank Value Visa Card, which offers a 12.99% interest rate.
Balance Transfer APR
Balance transfer APR is the interest rate charged on balances transferred from another credit card to your credit card. This rate is often lower than the purchase APR and can help you save money on interest charges.
It should be noted that this is not an efficient method of debt management. If you are struggling with debt, check out our article on some strategies that help effectively manage debt.
Cash Advance APR
The cash advance APR is the interest rate charged on cash advances made with your credit card. This interest rate is often much higher than the purchase APR, making it one of the most expensive types of credit card interest rates.
On average, cash advance rates tend to be between 20% and 23%. For example, the TD Cash Back Visa card has cash advances rates set to 22.99%. So, it’s best to carry a little bit of cash in case of an emergency rather than taking a 23% hit withdrawing money from an ATM.
Penalty APR
The penalty APR is the interest rate charged on your credit card balance when you fail to make your payments on time. This interest rate can be significantly higher than the purchase APR, making it even more challenging to pay off your debt.
How are Credit Card Interest Rates Calculated?
Credit card issuers use different methods to calculate interest rates. Here are some of the most common methods:
Average Daily Balance Method
The average daily balance method calculates your interest rate based on the average balance on your credit card over the billing cycle. The issuer adds up the balance on each day of the billing cycle and divides it by the number of days in the billing cycle.
This is the most common method of interest rate calculation given its simplicity and transparency. In fact, in Canada it is the only method allowed.
The following methods described are used for various other forms of debt, or on credit cards in other countries.
Two-Cycle Billing Method
The two-cycle billing method calculates your interest rate based on the balance over two billing cycles, which could lead to higher interest charges. This method takes the average of the balances from the current billing cycle and the previous billing cycle.
Adjusted Balance Method
The adjusted balance method calculates your interest rate based on the balance at the end of the billing cycle after subtracting payments made during the cycle. This method can help you save money on interest charges if you make payments during the billing cycle.
Previous Balance Method
The previous balance method calculates your interest rate based on the balance at the end of the previous billing cycle. This method is often used for cards that have a grace period, which allows you to pay off your balance without incurring interest charges.
Factors that Affect Credit Card Interest Rates
Credit Score
Your credit score is one of the most significant factors that determine your credit card interest rates. If you have a high credit score, you are more likely to get lower interest rates.
Many cards offer fixed rates to all consumers, but they can sometimes be negotiated depending on the product and issuer. Your credit score also plays a role in the interest rate given to you for other forms of debt, such as loans or lines of credit.
Payment History
Your payment history is another critical factor that affects your credit card interest rates. If you have a history of making your payments on time, you are more likely to get lower interest rates.
If you have a pre-existing relationship with the issuer, they may have higher confidence in your ability to repay debt and offer you a more attractive interest rate.
Debt-to-Income Ratio
Your debt-to-income ratio is the ratio of your monthly debt payments to your monthly income. If you have a high debt-to-income ratio, you are more likely to get higher interest rates because lenders see you as a higher risk borrower.
Type of Card
The type of card you have can also affect your credit card interest rates. For example, premium cards often come with higher interest rates than basic cards because they offer more benefits and rewards.
Economic Factors
Economic factors such as inflation, the prime rate, and the federal funds rate can also affect credit card interest rates. If the economy is doing well, interest rates may be lower. However, if the economy is struggling, interest rates may be higher.
Tips for Managing Credit Card Interest Rates
Managing credit card interest can be challenging, but there are a few things you can do to help manage your debt effectively:
Pay on Time
Making your payments on time is crucial for maintaining low interest rates. Late payments can result in penalty fees and higher interest rates.
In fact, we hope that you find this article completely useless since you should never have to face credit card interest rates if you pay your balance on time.
Pay More Than the Minimum
If for some reason you find yourself in a situation where you cannot pay your complete balance in one month, paying more than the minimum required payment can help you reduce your balance and save money on interest charges over time.
Use Balance Transfer Offers
If you have a balance on a high-interest credit card, consider transferring your balance to a card with a lower interest rate. This can help you save money on interest charges and pay off your debt faster and at lower cost.
Monitor Your Credit Score
Monitoring your credit score regularly can help you identify any changes that could affect your interest rates. If you notice your score has dropped, you may need to take steps to improve it to get lower interest rates.
Conclusion
Credit card interest rates can be confusing, but having a good understanding of them is essential for managing your finances effectively. Knowing the different types of interest rates, how they are calculated, and the factors that affect them can help you make informed decisions when it comes to managing your credit card debt. By following the tips outlined above, you can take control of your interest rates and avoid getting into debt.