What You Need to Know About Credit Card Rates

Imagine how wonderful credit cards would be if they didn't charge interest. You'd get the safest way to pay, plus perks, extra consumer protections, and miles, points or cash back all for free -- unless you opted to pay an annual fee for extra services. For close to half of Americans, that's already a reality, because they never carry forward balances to the following month. The rest, probably a small majority, do sometimes, often or always have credit card debt. And they pay a high price.

Credit card rates today
According to the IndexCreditCards.com rates monitor, the average consumer non-rewards card was charging 15.48 percent APR in mid-August, while the same figure for a consumer rewards card was 17.83 percent. That "APR" stands for "annual percentage rate," and represents the actual yearly cost of borrowing over the entire term of a loan. So short-term loans can be less expensive than they sound. For example, if you borrow $100 for three months, the actual interest you'd pay at 17.83 percent APR would be just $4.38, according to one of this site's credit card calculators.

Still, that's not cheap compared to some other forms of borrowing. And those APRs are averages: IndexCreditCards.com writer Richard Barrington is an expert on rates, and reckoned that, in August 2014, someone with a great credit score could find an APR 4.1 percentage points lower than someone with an average one.

How rates are set
Just about every card's rate is based on a prime rate, often the one published daily in The Wall Street Journal. This reflects the rate banks charge their most secure and creditworthy customers -- usually huge, global corporations -- for borrowing, and has been stuck at 3.25 percent for ages now. If you have variable-rate plastic (and vanishingly few products nowadays have fixed rates), then your issuer should have identified in your card agreement both the prime rate it uses and the "spread" you have to pay, which is the amount in percentage points on top of that prime rate you're going be charged.

So, if your card currently charges a 17.25 percent APR, and your issuer uses the Journal's prime rate of 3.25 percent, your spread is 14 percent. And, when the prime rate goes up, your rate should too, and by the same amount.

This can happen automatically, and without notice. However, according to the Federal Reserve:

  1. The new rate can only apply to new purchases. Your existing balance should continue to attract the rate that was in force when you charged the purchases, cash advances or whatever that created the debt.
  2. That means, if rates start changing frequently, you could have numerous APRs being applied to a single card.
  3. However, your issuer must apply each of your monthly payments to the portion of your balance attracting the highest APR at that time.
  4. Your issuer can change your spread whenever it wants. But it must provide you with at least 45 days' prior notice, and give you the option of cancelling your card. If you do that, credit card companies must allow you time to repay the debt. That can be up to five years, but they are entitled to increase your existing minimum payment by up to 100 percent.
  5. You don't get the 45 days notice of rate changes if you're reaching the end of an introductory offer and are just reverting to the published go-to rate, if you've previously agreed a repayment plan with your issuer and have failed to honor your commitments, or if you legitimately incur a penalty rate.

It's important to remember that most plastic charges a different interest rate for cash advances and sometimes balance transfers from the standard one applied to purchases. Cash advances in particular can be seriously expensive.

When will rates go up?
Just about every expert agrees that the question posed in that subheading is correct: You have to ask when -- not if -- rates are going to rise. At the time of writing, the Federal Funds Rate is close to zero (0.09 percent), so there's really only one way for it to go. And the debate within the Fed committee that determines rates is raging. Hawkish members want a rise right away, while even most dovish ones expect some upward movement during or before mid-2015.

And, when Fed rates rise, it's pretty much inevitable that prime rates and credit card rates are going to, too. This is unlikely to bother most cardholders all that much: close to half pay down balances in full every month, and many of the rest probably carry small balances for short periods, just to smooth out their cash flows.

But a significant group uses credit cards differently. Its members rely on their plastic to get through to payday. And they have no choice but to keep charging purchases, pretty much regardless of the prevailing rate. If you're in that position:

  1. Remember that the Fed is going to be doing its best to make sure any rate rises are slow and gentle, though nobody can make any promises.
  2. You almost certainly still have months -- maybe a year or so -- to try to reduce your dependency on your cards. That's easier said than done, but, if you're using them for occasional treats, now might be a good time to start resisting temptation.
  3. Whatever you do, try to avoid cash advances. They can be ruinously expensive. It's much cheaper to pay for your morning coffee and other small items as purchases on your card.
  4. Higher rates are almost certain to mean it takes you longer to pay down your card debt. Use this site's credit card calculators to model different rate scenarios and see how this might affect you.
  5. If your credit's still good, consider moving your card debt into a different form of borrowing with a lower rate, such as a personal loan from your bank. If you're a homeowner, a home equity loan or home equity line of credit (HELOC) could slash your interest costs and monthly payments, though these products require you to put your home on the line if you fail to keep up payments.

That last bullet point goes for everyone. Credit cards are by far the best way to pay for purchases, but, for most, they're lousy ways to borrow. If you've a good credit score, you probably have cheaper options.

This article originally appeared on indexcreditcards.com.

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