When you need to pick up groceries or gas up the car, you might whip out your credit card without thinking twice (especially if you’re earning rewards). But if you carry a balance from month to month, there’s one thing you shouldn’t ignore: the interest rate.
How do banks set the interest rates they charge?
We usually think of credit card rates in terms of APR, or annual percentage rate. This is the yearly rate you pay to borrow money on credit. Most credit card companies use variable APRs, which means the rate you’re charged fluctuates along with a benchmark rate such as the Prime rate (the rate banks charge each other). Your rate is probably the Prime rate plus a set number of percentage points. If the benchmark rate goes up, credit card rates usually go up, too (and vice versa).
Credit card companies decide where to set the APR for individual cards. It’s not unusual to find cards that have a range of APRs; for example, you might come across a card that has an APR range of 11.99 percent to 21.99 percent. The APR that applies to your account depends largely on your creditworthiness (your credit score and credit history). Your income can also come into play.
The initial rate you start with may change over time. If you sign up for a new credit card with a promotional rate, you’ll eventually be switched over to the regular rate. As mentioned already, changes in the Prime rate can affect your rate. Missing a payment could a trigger penalty APR. And under the 2009 CARD Act, credit card companies can raise your rate for any reason once your account’s been open a year.
It’s a good idea to take the time to learn about and understand your interest rate and how it works. The higher your rate, the more your purchases cost when you pay your balance off over time.
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How different rates translate to different costs
Your credit card probably has more than one interest rate. You may not pay the same interest rate for every kind of transaction.
Here are the most common types of APRs credit cards may charge:
- Regular purchase APR: This is the rate you’ll pay for purchases when you carry a balance from month to month.
- Regular balance transfer APR: This rate applies to balances you transfer to the card. The balance transfer APR can be the same as the purchase APR or a different rate altogether.
- Promotional or introductory APR: A promotional or introductory rate is a special rate that applies for a specific amount of time. Once the promotional period ends, the regular APR applies; cards can offer promotional rates for purchases, balance transfers or both.
- Cash advance APR: The cash advance APR kicks in when you make a cash withdrawal from your credit card limit. There’s no grace period on a cash advance. That means interest starts accruing on the day of the transaction.
- Penalty APR: Credit card companies can charge a penalty APR when you pay late. The average penalty APR is around 30 percent. If you get hit with a penalty APR, you can ask the credit card company to review your account after six months and consider reverting you to the regular APR.
All of the APRs your card charges are spelled out in your card agreement and on your monthly statement.
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Read moreWhat’s the average credit card rate?
Average credit card rates have increased steadily over the last year or so in reaction to the Federal Reserve hiking interest rates several times. As of March 2020, the average APR on new credit card offers was 17.08 percent. That’s a record-high level.
That number applies to all credit cards across the board. When you break down APRs for specific types of cards, the numbers vary. Here’s how average card rates compare for some of the most popular card types:
- Low-interest cards: 14.67 percent
- Cashback cards: 17.58 percent
- Balance transfer cards: 16.90 percent
- Business credit cards: 15.24 percent
- Airline cards: 17.50 percent
- Rewards cards: 17.55 percent
(Source: www.creditcards.com. Percentages are as of April 3, 2019)
Not surprisingly, the highest average card rates apply to cards that are designed for people with bad credit. The average APR for those cards is 25.33 percent.
A low-interest, plain vanilla card could yield the lowest rate on purchases. The downside is that these cards typically don’t come with many bells and whistles. That means no cash back, no cushy travel perks — you get the picture.
You’ll pay a higher APR to earn cash back, airline miles or travel points. Earning credit card rewards can save you money, especially if you do most of your spending on a credit card. Keep in mind, however, that the interest you pay eats into the value of those rewards. You might earn $300 a year in cash back, for example, but if you’re paying $500 a year in interest, the math doesn’t work out in your favor.
How to get the best card rate for you
The best way to avoid interest charges on a credit card is to pay your bill in full each month, but that’s not always realistic. The next best thing is to find a card that offers you the lowest rate possible, based on your creditworthiness.
Working on improving your credit score is a good way to start. Generally, credit scores are based on five things:
- Payment history
- Credit usage
- Credit age
- Inquiries for new credit
- Credit mix
The most impactful thing you can do to raise your credit score is to pay your bills on time. Set up payment due date reminders to cut down on the chances of missing a payment or paying late. Go one step further and consider putting your bills on autopilot and paying them from your bank account automatically each month.
The other thing you can do is pay down the balances on your credit cards. This can improve your credit utilization ratio (how much of your credit limits you’re using). If you can get this number below 30 percent, that’s a good start; 10 percent is even better.
You might be able to lower your APR all the way down to zero, at least temporarily. If you carry a balance, consider transferring it to a card with a lower rate. Shop around for a balance transfer promotional offer that you have a good shot at qualifying for, based on your credit profile. You could potentially save money and improve your utilization ratio at the same time.
Finally, you could always try reaching out to your credit card company and asking for a lower rate. If your account’s been open for a while, you’ve always paid on time and you’re not maxed out on the card, they may be willing to trim a point or two off.
Your finances will thank you for getting the best credit card rate
If credit cards are a regular part of your financial routine, snagging a low APR can be huge for your money goals. The less you pay in credit card interest, the more money you have to save, invest and spend on things and experiences that you truly value. Knowing where you stand with your card rate and taking steps to secure the best rate possible can benefit your financial health now and in the future.
Rebecca Lake is a financial journalist at Credit Sesame. She has a Bachelors in Political Science from the University of South Carolina. She covers the intersection of public policy and personal finance.
The opinions expressed in this article are the author’s own. Haven Life Insurance Agency offers this as educational information only. Haven Life does not endorse or offer the products, services and/or strategies discussed here.
