Understanding Credit Card Interest: Fees, Rates & How to Save

Anyone who has ever carried a balance on their credit card knows there’s a big difference between the actual amount you spend on credit — otherwise known as your principal balance — and the amount credit card issuers ask you to pay at the end of the month. This interest represents the fee you’re paying to credit card companies for the privilege of borrowing money.

Before signing up for a credit card, it’s especially important to read the fine print as it pertains to interest. Otherwise you could find yourself owing more than you anticipated if you’re unable to pay your balance in full.

Here are a few important things to keep in mind about credit card interest.

 

Here’s How Credit Card Companies Set APR

Credit card interest is expressed in terms of annual percentage rate (APR), or the interest you’ll have to pay over the course of the year. But APR is not set in stone — in fact, two people with the same type of credit card could very well find out they’re paying different APRs.

One factor determining APR is the prime rate, meaning the general state of the economy plays a role. Prime rates are set by banks to reflect the rates they charge their best customers.

So, as one consumer finance expert notes for U.S. News & World Report, your APR will be a reflection of the prime rate plus a margin of profit for the lending institution. If the prime rate is five percent and the bank adds a 10 percent margin, the APR you’ll see is 15 percent.

Another major factor lenders take into consideration on a credit application is your credit history, which reveals how you’ve used credit in the past. Your employment history and income may also play a role.

The type of card you carry matters too. Some, like department store cards, tend to carry higher interest rates. Rewards cards also tend to charge slightly higher APRs than traditional cards.

 

Typical Interest Ranges from 15 to 20 Percent

As we mentioned before, the type of card will factor into your interest rate. But it’s safe to say 15 to 20 percent is a pretty typical range as far as APR goes. In 2018, the average rate on interest-bearing accounts was 15.32 percent.

 

Americans Pay A Lot in Interest Each Year

The total amount of credit card debt in America is near $1.1 trillion. But, according to Investopedia, Americans were collectively paying up to $121 billion in interest and fees alone as of late 2019.

Credit card interest accumulating on outstanding balances can make it very difficult to pay down debts. Thankfully, there are strategies to consolidate credit card debt worth exploring. A balance transfer can move debt from a high-interest card to one with no interest for an introductory period — for a small fee. Borrowers with strong credit may also qualify for a low-interest personal loan, which they can use to pay off their cards. Entering into a debt management plan through a credit counseling agency may also earn enrollees reduced interest and waived fees, provided they stick to the terms of the plan.

 

Missing Payments Can Trigger Penalty APR

Missing one payment can earn a late fee. Missing two or more payments can earn a penalty APR rate higher than the usual one — up to 29.99 percent. If you do trigger a penalty APR but miss no more payments and violate no more terms of your cardholder agreement, your interest rate will usually return to normal after six months. Some card issuers will continue to charge the penalty APR on future purchases until your balance is paid off; policies vary.

There’s a lot to know about credit card interest, but understanding how it works can help you avoid racking up unnecessary debt.