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June 09, 2007
Simplistic Explanation of Credit Card Rates
Credit card debt is soaring out of control for many Americans. It amazes me to see just how much consumers are spending each year with their credit card, it’s in the trillions of dollars!
It is predominately young families and people in their late teens and early twenties that venture on a course of the burdens of credit card debt because they do not fully understand the fees and interest rates associated with the ticking time bombs in their wallets, otherwise known as credit cards.
The Federal Reserve is at work to help the average consumer avoid the despair cause by debt by looking at ways to improve credit card company disclosures, billing and what are quite often confusing interest rates. You can read the press release here from the Federal Reserve to see what actions they are taking.
While I think it’s a very good thing that the Federal Reserve is working to make it easier for consumers to understand what they are signing on for when they apply for a credit card, ultimately your finances should really be your own responsibility.
You must educate yourself about what the lingo used in the various aspects of personal finance means.
When talking about credit cards there are several charges and fees that the card issuers make money from you.
How much are you really going to be paying in interest? To better understand credit card interest rates I am going to explain the most common areas of confusion consumers have when they are trying to compare rates.
Let’s take a look at how the banks make money from your use of credit cards. It gets confusing trying to figure out what all the different interest rates mean and what the different charges are for.
Bank Fees and Interest Rates Explained in Simple Terms
1. Annual fees
Most credit card companies charge an annual fee. This is a flat rate that you pay each and every year to be a cardholder whether you use the card or not. Make sure you read the terms and conditions when you are applying for a credit card and look for the annual fee.
Tip: When you apply ask the bank to waive the annual fee, quite often they will.
Why is there an annual fee?
First of all it mitigates the risk of people defaulting on payments. Secondly it’s a cash grab pure and simple. The credit card company wants to make a fast buck from you.
An annual fee really comes down to this: You are paying the bank to be a customer.
2. Purchase interest rate
Typically there is an interest rate assigned for purchases of merchandise from stores. This rate applies to goods and services you purchase on the credit card.
3. Balance transfer rate
You might see a balance transfer rate on the terms and conditions of the card you are applying for. This is a rate that is set to entice you to leave your current credit card company to attract you as a new customer.
Note: The balance transfer rate will only apply to the balance you transfer from your old card to the new company. Any new purchases you make with the card will accrue interest.
Why do banks offer 0 APR balance transfer offers?
Simple, they figure that since you carry a balance you are likely to increase your spending with their card and they are going to make money from interest accrued by your credit card use.
Tip: Use balance transfer rates to get out of credit card debt. Take advantage of the several zero interest introductory APR’s to get out of debt.
How?
Transfer your balance to the 0 APR card and do not use your credit card! Discipline my friends!
4. Cash advance interest rate
The rates on cash advances from ATM’s are typically double that of purchases. When you take money out of the ATM as cash it’s going to cost you a lot more than you could ever imagine!
Tip: Never withdraw cash on your credit card from an ATM! Ever!
5. Variable rate
A variable rate will usually read, Prime plus a percentage. While you will see some seemingly low rates on variable rate credit cards, the number you see is not the interest rate you will pay.
The variable rate might read 7.99%
You think you are getting a great deal!
No! That’s not the rate you will pay. The variable rate of prime + 7.99 will be more than the 7.99!
The prime rate is a base interest rate set by the banks so if prime is 4% for example, the real interest rate you will pay is 11.99%
6. Fixed rate
A fixed interest rate is just that, it’s a pre-determined interest rate which never changes on your card unless the issuer notifies you in accordance to applicable credit laws.
Tip: When the bank sends you information in the mail, read it all! It could be them announcing a rate hike!
That’s about as simple as I can state the various rates charged by credit card companies, when you have a basic understanding of how the various fees and rates work, you are armed with knowledge and I hope that knowledge will help you avoid credit card debt.
Educate yourself on the basics of how credit cards work and you will be able to avoid credit card debt or begin to shed yourself of the burdens of debt.
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