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Credit Card Interest Rates Explained

So you’re thinking about getting a credit card? Or, you’ve got a credit card but you’re looking at it just wondering how to use it to make it work for your financial goals!

You’re definitely not alone. It’s complicated and no one wants to end up with bad credit, or buried under a mountain of debt! That’s why we put together this simple guide to help you crack the credit code and understand different types of credit cards and their interest rates.

Once you unlock the secret credit card handshake, you’ll be able to navigate the different offers that are out there and choose the right option for you! But if you’re looking for a card that comes with friendly, personalized customer service (along with other great features like low fixed rates, instant in-branch card issues, and rewards on every purchase), UMe’s got the goods!

The UMe Difference

Okay, things are about to get kinda technical. Before we get into the weeds on exactly how card interest rates work, it might be helpful to have an amazing real-life credit card in mind to help give you some context.

A UMe Visa Credit Card comes with a variety of cool benefits and perks, including:

  • Rewards (including a cash-back option!)

  • Fraud protection, detection, and resolution

  • Convenient and quick online payments with Visa Checkout

  • Zero balance-transfer fees

Find out more about UMe credit cards here.

How Credit Card Interest Is Charged

One important thing to know is that you aren’t automatically charged credit card interest. Your card issuer only starts to charge interest when you carry a balance over from one month to the next.

Credit cards each have an Annual Percentage Rate (APR). Banks and financial institutions calculate interest based on something called the daily periodic rate. You can determine this with some good old-fashioned math.

Look at your statement to see which days your billing period includes. Identify your unpaid balance from last month that you’re bringing into the next month. The calculation is a bit tedious, but you’ll need to go day by day, writing down the balance for each day, since it will go up and down depending on whether you’ve made a payment (your balance goes down) or a purchase (your balance goes up).

Then, remember pre-algebra middle school and calculate your average daily balance by adding up the total balance and dividing by the number of days. Multiply the result by your daily periodic rate. 

Hold on. Math class isn’t over yet...

Multiply the result again by the number of days in your billing period. Pay attention to whether your credit card company compounds interest on a daily or monthly basis. (Compounding simply means adding the interest you’ve accrued to your unpaid balance, which means you end up paying interest on top of the interest you’re already paying.)

You may find the result ultimately is that you pay more than your APR. Knowing how much interest you’re really paying can help you budget accordingly to bring down (or ideally, pay off) your card balance!

How to Avoid Paying Interest

The good news is, you aren’t doomed to an endless cycle of paying interest on credit cards. There are some simple and relatively painless ways to avoid snowballing interest.

First of all, if it’s possible, pay off your entire balance every month. Yup, entire balance, every month.

If paying off the whole balance isn’t possible, try to avoid paying only the minimum payment listed on your statement. Paying more than the minimum payment can help keep your daily balance down, which can keep your daily credit card interest rate down, which means smaller interest payments.

Another hack to avoid your interest spiraling out of control is to make payments on your bill a few times a month. This avoids one large payment but still keeps your interest down.

Why Does My Card Have Multiple APRs?

Some cards charge a different APR (Annual Percentage Rate)  depending on the type of transaction. The APR on purchases might be different from the APR on cash advances.

Credit card companies determine APRs in a couple of different ways. In some cases, they might offer one APR for everyone across the board. In other cases, the APR can differ from customer to customer, depending on an individual’s credit score and history. In this case, someone with excellent credit will have a lower interest rate than someone with a lower credit score and spottier credit history.

Additionally, different types of cards will have different interest rates. A rewards credit card usually has a higher interest rate than some other options, as well as cards for bad credit.

What Are the Different Types of Credit Card Interest?

What is a “prime rate?”

Interest rates are tied to something called the prime rate, which is an index of interest rates that banks charge their preferred or biggest customers. It’s related to the federal funds rate, which is how much interest banks charge each other for loans, and is determined by the Federal Reserve (also known as “the Fed”).

The prime rate is usually a little higher than the federal funds rate. The prime rate goes up or down depending on a variety of external factors, such as when the Fed decides to cut interest rates in response to a financial crisis like a recession. The prime rate can also stay the same for quite a while. When the prime rate changes, so do interest rates everywhere else.

Fixed vs. Variable Interest Rates

In order to choose the right card for you, you must understand the key differences between a fixed and a variable rate.

When you have a card with a variable interest rate, the interest charged on your card’s outstanding balance will fluctuate based on an underlying benchmark or index that can change (remember that prime rate we talked about earlier?).

A fixed interest rate, on the other hand, remains the same regardless of changes to the prime rate.

What is a Good Credit Card APR? 

So how do you make sure you’re getting the best APR available to you?

The simple answer is to have good credit. The better your credit, the better your interest rates on your balance. Cards often have a range of APRs, with the lower ones going to folks with good credit. The higher end of the range is where you’ll find the people who may need a little bit of help with their credit history.

It can be helpful to have a benchmark to work from, however, so you may find it useful to know that as of February 2021, the Federal Reserve said the average APR on credit cards was 15.91%.

Credit Card Interest Rates and U

Of course, this is just the beginning of credit card ownership. There are many different kinds of cards: rewards cards, balance transfer cards, and more. Furthermore, different things such as late payments can impact your APR.

For a card with low, fixed rates, friendly (and personalized!) customer service, and a range of rewards –– including cash back — look no further than UMe! 

Want to find out more about the mysterious world of credit cards? UMe has got U covered.

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