While mortgage and auto loan rates remain unusually low, don’t expect your credit card rates to drop as well. Unlike your home or car loan, credit cards are mostly unsecured loans, “so there is no collateral,” says Miriam Mitchell, senior vice president of lending at Addition Financial.
Credit cards are “largely risk-based,” she says. Default rates for credit card rates are also higher than for other types of loans, Mitchell said.
Despite much higher credit card rates, you can choose to reduce or not pay this particular percentage. The trick is to take steps to reduce – or eliminate – what you owe on your credit cards.
How are credit card rates set?
Credit card interest rates are pegged to the prime rate, which is based on the federal funds rate set by the Federal Reserve. According to our sister site The Points Guy, the federal funds rate is currently 1% and the prime rate is 4%.
The Federal Reserve cut the federal funds rate by 0.5% in March 2020 due to the COVID-19 pandemic and it recently rose to 1%.
Most credit cards have variable interest rates, and the rates can go up or down along with the base rate.
Why does the APR on a credit card change?
Your credit card interest rate, as well as the installment loan rate, is calculated as a percentage of your account balance and then recalculated on an annualized basis to determine the Annualized Percentage Rate (APR).
The average credit card interest rate contrasts sharply with the federal funds and prime rate and is currently north of 16.50% per annum, according to CreditCards.com’s weekly rate survey.
When the Fed cut rates, many experts expected annual interest rates on credit cards to fall as well. But that didn’t happen, says Melinda Opperman, president of Credit.org, a nonprofit consumer credit advisory agency.
“We feel that the underlying health of the economy — the very reason the Federal Reserve is cutting rates — is forcing lenders to keep credit card rates high,” Opperman says.
While the Fed hopes to stave off a recession with lower rates, “the mere threat of a recession is forcing lenders to keep rates high,” she adds.
With credit cards, “the lender is compensated for the risk,” says Jason Vissers, credit card analyst at MerchantMaverick.com.
How is the APR calculated on a credit card?
Not everything is out of your control. Your credit score and the type of card you choose can affect the rate you pay.
A CreditCards.com rate study found that the average annual interest rate on a credit card is 16.59%. But the average rate for the low rate card was 13.55% and the average for the bonus card was 16.41%.
Higher rates “help pay for more lucrative card benefits” such as rewards programs, Vissers said.
Your credit score also plays an important role. Mitchell says that consumers with a credit score of 740 and above tend to get better rates on their credit cards.
Your credit score takes into account things like your payment history, debt level, and the length of your credit history.
“Consumers with little or no credit history will pay much more than those who are well-established, with a history of monthly on-time debt repayment,” says Opperman.
The card issuer you choose can also affect your APR, Mitchell says, since credit unions often charge lower rates than the big banks.
If you pay your credit card bill monthly, the annual amount charged to your card may not matter much to you. The perks your credit card provides, such as rewards or insurance payments, may be more important to you than the annual interest rate.
But if you have a balance sheet, interest payments can quickly add up—and diminish the value of those other perks.
How to reduce the APR on your credit cards
There are many ways to lower your credit card rates:
Improve your credit score
If you have a good credit history, you can negotiate a lower interest rate with your card issuer, Vissers says.
If your credit score has improved since you opened this credit card, the issuer may be even more willing to lower your rate, Opperman said.
The best way to improve your credit score, she says, is to make monthly payments on time. Also, double check your credit report for outdated or inaccurate information.
“Anything you do to improve your credit history should help you pay lower rates in the future,” says Opperman.
Try to transfer the balance
Another option could be to transfer your card balance to a credit card with a balance transfer at a starting interest rate of 0% for a limited time, such as 12 or 18 months, according to Vissers. But you have to be vigilant and pay off your balance before the 0% APR period expires or you will start paying high rates again.
Balance transfers also usually require you to pay a transfer fee, which is usually between 3% and 5% of the amount you are transferring.
However, balance transfers can backfire if you transfer existing balances to the new card and continue using the old one, says Opperman.
“We see a lot of people looking for a loan counselor who [have] doubled their debt because they transferred the balance and kept borrowing with the original card,” she says.
Find the best credit card
When looking for a new credit card, Mitchell says, you need to understand its purpose and how you will use it.
Use tools like CardMatch to measure your creditworthiness for specific cards and compare options from different financial institutions, including annual interest rates, benefits and conditions. “One institution can be very different from another,” she says.
“Purchasing the right credit card will be key,” Mitchell says.
bottom line
While credit card APRs are higher due to the risk they pose to lenders, you can lower yours by improving your credit score or transferring your balance to a card with a starting rate of 0%. In addition, you can avoid interest charges by paying off the balance every month.
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