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What You May Not Know About Your Credit Card's Interest Rate

Jason Steele

Credit cards can appear to be simple financial instruments, but behind the plastic can lie an intricate arrangement of terms, conditions, rates and fees. And for those who carry balances, it’s important to know how much you will have to pay in interest.

When researching these costs, cardholders are often confused by the terms “interest rates “and “APR.” An interest rate is a percentage of the balance that is charged over a defined period of time. So an account can have a daily interest rate, a monthly, or periodic interest rate, and an annual interest rate. That is where the term APR, which stands for Annual Percentage Rate, comes in.

How APRs Differ From Interest Rates

With other types of loans, such as a home mortgage, the interest rate includes just the basic payment on the account holder’s balance, or principal. The term APR is used to include other costs and fees in these types of loans. In fact, lenders are required to disclose the APR, which includes all required fees. But with a credit card, there are rarely any required fees imposed on a balance over time, so in this case, the terms interest rate and APR are largely interchangeable.

Why APR Is Important

APR is the amount of interest that you would pay over the course of the year on an unpaid balance. This presumes that your balance remains the same, which is unlikely as cardholders typically have interest charges added to their balance each month, make monthly payments, and use their cards to make new purchases. So using a period of a year to define the interest rate is actually somewhat arbitrary, kind of like using “miles per hour” to define speed, even though one’s speed may vary, and drivers may not be on the road for an entire hour.

With most credit cards, customers have the option to pay off their entire balance in full before their statement due date in order to avoid any interest charges. Yet studies consistently show that between one half and two-thirds of all credit card users carry a balance on at least one of their cards each month.

Other Commonly-Misunderstood APR Facts

First, most credit cards are no longer offered with a single APR. For example, the popular Chase Freedom card is offered with three different rates of 13.99%, 18.99% or 22.99%, depending on the cardholder’s creditworthiness at the time of application.

Second, nearly all credit cards offered today feature an APR at a variable rate that is dependent on the prime rate. The U.S. prime rate is set by the Federal Reserve bank, and has remained steady at 3.25% since December of 2008. And while analysts do not expect the rate to increase soon, it is possible that it will go up, and that would affect the interest rates of nearly every American credit card user.

Thankfully, there is nothing fixed about the initial rate given to new cardholders. Card issuers determine cardholders’ rates based on their credit history when an account is opened, but there is no reason cardholders cannot request a lower rate in the future. (You can check your credit scores for free on Credit.com; this can also give you an idea of whether your credit has improved enough to warrant asking for a lower interest rate.) When cardholders create a record of on-time payments, and take other steps to improve their credit, credit card issuers will be more likely to lower their interest rates rather than risk loosing a good customer to a competing bank.

Note: It’s important to remember that interest rates, fees and terms for credit cards, loans and other financial products frequently change. As a result, rates, fees and terms for credit cards, loans and other financial products cited in these articles may have changed since the date of publication. Please be sure to verify current rates, fees and terms with credit card issuers, banks or other financial institutions directly.

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