No matter which credit card company you choose, you will inevitably find one major thing in common – a very high interest rate, and a zero-tolerance late payment fee. In fact, if you compare this interest rate to that of a mortgage or car payment it might even be twice as much. As of this month, the average annual credit card purchase interest rate (APR) lies at a hefty 16% for travel reward credit cards, all the way up to 21% on average for cash rewards cards.
But why are they so high?
The answer lies in a combination of profit and risk. Many credit cards charge no upfront cost or annual fee for use, but instead capitalize on monthly $35 late fees (which luckily the government capped!) and interest on statement balances at these soaring rates of 20% per year. As long as banks charge interest rates that are more or less on par with their competitors they will do their best to hike the rate as high as possible.
They start with this thing called a “prime rate” which is an index of interest rates banks charge their most reliable customers. The Fed also helps determine this rate – it’s normally around 3.5%. Then, depending on your individual situation and credit history, the bank will add a margin. This is usually a pretty healthy chunk if they ultimately end up at around 20%. The worse your credit history, the more risky a customer you are and thus the higher your APR. Credit card interest rates (and late fees for that matter) are significantly larger than those for mortgages etc. because banks have no collateral against your use of their credit cards (like a house or a car), so they adjust the rates to account for this increased risk.
How do you solve this?
Well, the 🔑 here is managing your credit history and credit score so that banks “trust” you more and in turn lower your respective interest rate. This comes from:
- Consistently paying your bills on time (and in full when you can)
- Budgeting to spend within your means and;
- Cutting out any frivolous expenditures.
Finally – do your best to avoid running a balance on your credit cards! That’s the only sure way to avoid these killer APRs.