Credit Card Interest Rates and What They Mean for You

When you’re shopping for a credit card, one of the most important considerations is the interest rate on the card. Whether you choose a VISA, MasterCard, Discover Card, department store card, or any other kind of credit card, you will have to pay interest on any unpaid balances. How much interest you pay depends on various factors.

But first, it’s important to appreciate the difference between a credit card and a debit card. As the name implies, a credit card advances you credit for purchases, allowing you to use the card until you reach a preset spending limit. With a credit card you are using (essentially borrowing) the card company’s money, and that company is trusting you to pay it back, with interest. Debit cards, on other hand, draw directly from your checking account. You also can purchase prepaid debit cards that can be used for the amount you paid in advance, and then reloaded when the funds are gone.

Managing Your Card Payments

When planning your household finances, it’s extremely important that you understand how interest rates work and how to manage credit card debt. For example, if you use a credit card with a high interest rate, your credit card debt can quickly get out of control if you aren’t careful. To help you choose the right credit card and manage your payments, here are a few things you should know about interest rates.

First, know your APR (annual percentage rate). The APR on a card is the rate you pay for the money you borrow by using your credit card; in other words, it’s the price of the loan. The lower the APR, the less money you will have to pay in interest. In addition to the APR, you should understand the monthly periodic rate. The periodic rate is a fraction of the APR. For example, if you have an APR of 12 percent, the monthly periodic rate would be 1 percent. Many companies charge interest based on the daily card balance using a periodic rate calculation; for example, 12 percent interest divided by 365 days is a daily interest rate of 0.033 percent.

When assessing APR and other credit card interest rates, it’s also important to know whether your card has a fixed interest rate or a variable interest rate. A fixed interest rate is set for a period of time and cannot be changed by the credit card issuer without advance notice. A variable-rate card, however, is tied to an index such as the prime rate and can change every time the prime interest rate changes, which may or may not be to your advantage.  

Most credit cards also have a cash advance option, which means you can use your card to get cash (at an ATM, for example). But be aware that cash advances come with fees, usually ranging from $5 to $10 per transaction. Plus, many card companies charge additional interest for cash advances—up to 5 percent more, depending on the cash amount. For example, if you have a credit card with a 15 percent APR, you may be charged 20 percent interest on cash advances.

Avoiding Interest Payments

If you want to avoid paying interest altogether, plan to pay off your credit card balance each month. Most card issuers (e.g., banks and credit unions) offer a grace period during which you can pay your credit card bill without having to pay interest. For example, if your card statement is dated the 5th of the month and you have until the 30th to pay the bill, then you have a 25-day grace period to pay any new balance without accumulating interest. Note, however, that cash advances do not typically have a grace period but tend to accumulate interest from the day you access the cash.

To provide incentives to use their cards, many credit card companies have rewards programs. Airline cards are popular with travelers and give customers one or more frequent flyer miles for every dollar they spend. Other cards offer travel points that can be used for hotels or restaurants, or points you can use at specific stores. The most popular types of cards are those that offer cash-back bonuses for purchases. If you are interested in a rewards card, be sure you clearly understand the terms of the rewards program so you know what benefits are available and how to redeem them.

When used wisely, credit cards can be a versatile part of your household financial strategy. However, to keep your credit card debt manageable, you want to be sure you understand how interest rates can affect your finances. Credit card debt in the United States is at an all-time high—the average American has a credit card balance of $6,375. To ensure that you get the right card to suit your needs, why not consult your credit union? iQ Credit Union has a VISA card with a low APR, cash-back program, and other benefits.