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Credit card interest rates
Least understood and usually the most dangerous ...
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And finally, we need to talk about interest rates. We left interest rates for the end because interest is the least understood and usually the most dangerous part of your financial dealings.
Mathematical equations aren't necessary to understand interest. You simply need to understand a few key facts about credit card interest.
- Credit card interest is compounded. You might remember the term compound interest from school. When you make a charge to your credit card and don't pay it right away, you pay interest on that charge. When you don't pay the next bill in full, you pay interest on the original purchase AND the interest that was applied to the original purchase. The interest is compounded again and again until you pay off the entire balance. You are paying interest on your interest, and it quickly compounds until you're making minimum payments and not using the card, but your balance just keeps growing!
- If you can, you should take advantage of the grace period and avoid paying interest at all costs. The interest that you will pay is the interest on the original purchase, not the balance. Let's say you bought a new TV for $5000 and charged it on your credit card. When the bill comes, you pay half - $2500. Your interest is going to be calculated on the $5000 purchase, not on the $2500 remaining on your card. Don't use your credit card to make purchases you can't afford.
- There is a lot of competition between banks who issue credit cards. They will often try to lure you to their bank with introductory offers of low or no interest rates. These deals can be helpful, but it's important that you are fully aware of what the interest rate WILL be after the initial time period. If you keep a balance on your card, it's better to have a card with a fairly low interest rate than to have a card with no interest rate for 6 months that turns into a very high interest rate.
- Some banks will not tell you a specific interest rate after the introductory period. They will use terms like US Prime Rate + 2%. It is your job to find the current prime rate to compare it to other cards. You can easily find this online or in business publications like The Wall Street Journal.
- Before transferring your balance to a new credit card, call your current bank to ask for a lower rate. Yes, it takes some bravery. People are usually intimidated by bank employees. But here's the bottom line - they want to keep your business. Explain that you are receiving offers for cards at lower rates and ask if they can compete with those rates. You might be surprised at the result.
- What do the news reports of changing interest rates mean to you? Over time, they can mean a lot. If the average national interest rate is much lower than when you originally received your credit card and you have basically the same or better credit, you can usually get a lower rate.
- Beware of retail store credit cards! There are limits on the interest rates that credit card banks can charge you. Retail credit cards can exceed this limit. Most retail store credit cards are around 20%. Some of them go quite a bit above 20%! While you might be tempted to get 10% off your purchase by signing up for a store credit card, you'll end up paying much more than that in the long run!
While your credit history, credit reports, and credit cards can seem confusing, your best weapon is knowledge! When you understand how your credit works, you know what to do to improve your credit. Truly understanding interest and credit card fine print can help you use credit opportunities to your advantage and avoid being overwhelmed by debt. Lives are ruined when people don't fully understand the potential dangers of credit. Regardless of your current credit score, you are taking the first steps to a debt-free life by learning how the system works!
From: Understanding credit and credit cards (don)
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