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Credit Card Interest Rates - A Concise Explanation

Sep 15, 2008
When you apply for a credit card, all the different type of interest rates mentioned on the application form probably confuses you.

The most common interest rate is the APR, which credit card companies like to quote as the interest rate for using their card. This is known as the Annual Percentage Rate, which is calculated on a yearly basis.

However, credit card companies do not do their interest rate calculation once a year. They do it on a monthly basis. The interest is applied to your unpaid outstanding balance is calculated by dividing the APR by 12. This is called the monthly periodic rate.

Every month, this monthly periodic rate is applied to whatever outstanding balance that is not paid. This is the compounding effect of interest rate and is refer to as compounding interest. By factoring into the compounding effect, what have is called the Effective Annual Rate (EAR). This rate is much higher than the quoted APR rate.

Most of the credit card companies will offer two type of APR for their cards. The first one is the introductory rate, which is a very low rate and last for six months to a year. In many cases, the introductory rate is zero percent. Once the introductory period is over, second type of APR will comes in. This is often called the ongoing APR, which can be a huge jump from the introductory interest rate. Thus it is imperative to check the ongoing rate before applying for the credit card.

In addition, the ongoing APR can be fixed or variable.

A variable APR means that the rate will fluctuate according to changes to economic indicators such as the Prime Rate or the LIBOR Rate.

On the other hand, a fixed rate is not dependent on such economic indicators but it does not mean it stay unchanged over time. The credit card company can, and will, change it if necessary. However, it will do so after giving you some form of notification first. Unless the economy is facing some serious problem, the fixed APR can stay unchanged for many months.

The all the interest rate stuffs is making your head swim, you just need to do one thing. And that is to pay your credit card balance in full and on time. If you do this every month, there is really no need to worry about the interest rate.
About the Author
Want to learn more about credit cards besides the interest rates? Visit Stephen Chua's credit card blog and get your free copy of the Mini Credit Secrets book too.
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