When you have a credit card, worrying about paying your monthly statements is only part of the equation. If you carry a balance, you’ll be faced with paying interest on top of the amount you’ve charged. But how much will they charge all depends.
Interest Rate Averages
What you may assume to be a credit card interest limit is usually an industry average and your individual rates can change based on your creditworthiness. For example, travel-focused credit cards’ APR’s hover between 15% and 19%, but that doesn’t mean those rates are what everyone will be charged. Penalty interest rates — which are assessed if your account is maxed out or the balance is more than 30 days past due — can easily rise to 29.9% or more.
Are Interest Rate Hikes Legal?
It is legal for issuers to raise your interest rate, but they do have to follow some guidelines. Thanks to the Credit CARD Act of 2009, the following rules apply to consumer credit interest rates. Issuers cannot:
- Increase rates on an existing balance unless it is 60+ days overdue, the variable indexed rate increased or a promotional rate expired.
- Increase rates without providing 45 days’ notice and providing customers with the option of closing their accounts.
- Increase rates within the first year of opening the account, and promotional rates must be in effect for at least six months.
- Maintain a penalty rate after six months of faithful payments. For example, suppose you are 60 days behind on your payments and your interest rate increases. As long as you make timely payments for the next six months, your creditor must lower your interest to the previous rate.
- Raise rates on existing balances if a customer decides to close their account. The initial terms remain in place and the customer has five years to repay their balance.
What the Credit CARD Act Doesn’t Do
Limit Private Business Decisions: Raising rates depends on the discretion of your creditor. While most providers gauge their rates based on competitor performance, they can — with proper notice — choose to raise their interest rates at any time. While you have the option of closing your account, doing so could damage your credit history, a key factor in determining your credit scores.
Apply to Business and Corporate Credit Cards: Small business owners are not protected by the CARD Act’s legislation, adding a level of risk.
Provide a Maximum Rate: Although federal law limits how interest rates are assessed, it doesn’t determine how much. A particular creditor shocked customers in 2009 by charging 79.9% on revolving balance. Outrageous, yes. Illegal, no.
How Do Interest Rates Affect Credit?
Credit card interest rates are the X factor related to borrowed funds, and the variability can easily damage your credit. For example, suppose you have a credit card with a $5,000 balance. You have missed two payments and your interest rate rose from 18% to 29.9%. Unless you pay your balance immediately, the following consequences will occur:
- Your debt will increase to nearly $17,000 over the course of ten years (even while making minimum payments).
- Your balance will affect your debt-to-income ratio and ability to secure financing for a home, car, education, etc.
- The overwhelming debt will impact your emergency savings and ability to budget safely
The effects of high interest rates can cost you more than a few hundred credit score points: it can derail your plans and close financial doors in the process.
Remember the Five Factors of credit scoring and monitor your interest rates carefully. You likely don’t want to allow interest rates on borrowed funds to hurt your future.