For all people shop around for the best rate, there are few who have taken the time to sit down and add it all up. After all, why would you bother? The answer is that understanding just how interest rates work can help you see how important small differences in rates and payment amounts can be.

Interest Rates are Compound.

It is important to remember that what you owe is compounded – that means you pay interest on the interest you owe from the month before. That means that if you’re paying 2% per month in interest, you’re not paying 24% per year – you’re actually paying 26.82%. Charging interest monthly instead of yearly is a trick to make it feel like you are paying a very low price for your borrowing.

A Thought Experiment.

Here’s a question: would you rather have $1 million, or $10,000 in a savings account earning 20% per year in compound interest?

Well, let’s see how that $10,000 would grow. After 10 years: $61,917. 20 years: $383,375. 30 years: $2,373,763. 40 years: $91,004,381. 50 years: $563,475,143.

So after fifty years, you’d have over $500 million?! Well, not so fast. Of course, you have to take inflation into account – if we say inflation is 5%, then that money would have the buying power that $10,732,859 does today. Still, that’s not a bad return on your investment of $10,000, is it?

That’s the power of compound interest, and the way the credit card companies make their money (it’s also the way pensions work, and the reason the prices of things seem to rise massively as you get older). Be very, very afraid of compound interest. Or, of course, you could start saving, and be very glad of it…

Compound Interest Adds Up.

Let’s work through an example on a more real kind of scale. Let’s say you have an average unpaid balance of $1,000 on a card at 15% APR.

You will owe $150 in interest for the first year you borrow. However, this amount is then added onto the balance, and interest is charged on that. The second year, you’d owe another $172.50, for a total of $1322.50. It goes on, with totals like this: $1,520.88, $1,749, $2,011.35.

After just five years at 15%, you’d owe double what you borrowed. And after 10 years, you’d owe four times what you borrowed! Bet you weren’t expecting that. If you let something like that carry on for long enough, you’ll end up paying back that credit card for years afterwards, paying back what you borrowed many times over and still not clearing the debt. Most people don’t work this out, and feel that the payments must simply be their fault for spending too much money to begin with.

One Percent of Difference.

One more thing. You might think there’s not that much difference between a card that charges 15% APR and one that charges 12% APR. Let’s see the difference the lower rate would make to that $1,000 borrowed for five years. Remember, after five years at 15%, you owed $2,011.35.

At 12%: $1120, $1254.40, $1404.93, $1573.52… $1762.34 after five years. So you’ve saved $249.01 from that 3% difference in APR – in other words, you’ve paid almost 25% less interest.

All about credit card rate

What’s the thing that is most prominent on any credit card ad? Well, it’s the credit card rate (or the APR, as we know it). The credit card rate is the most publicized thing in the world of credit cards. A lot of people just compare the credit card rate of various credit cards and just go for the one that is offering the lowest credit card rate (or APR). Credit card rates are, in fact, one of the most important factors in the selection of a credit card (though not the only factor). Therefore, a proper understanding of Credit card rates is even more necessary.

So, what is a credit card rate or APR? Very simply, credit card rate is the rate of interest that the credit card supplier will charge you with on the amount you owe them. The credit card supplier will charge you an interest only if you don’t make full payments in time.  When you receive your credit card bill, it specifies the full amount you owe the credit card supplier. It also specifies the minimum payment that you must make (by a particular date), in order to avoid incurring a late fee and other inconvenience. You have the option of making either a full payment or just the minimum payment. If you make a full payment (by the due date), you are not charged any interest. However, if you decide to go with the minimum payment or some amount that is lesser than the full amount, the credit card supplier will charge interest based on the credit card rate and the balance amount. This credit card rate is the interest rate that you agreed with them at the time of applying for the credit card. The credit card rate or the annual percentage rate, as is obvious, is an annual interest rate. The credit card suppliers use this annual credit card rate to calculate the monthly credit card rate and then they calculate the interest on the balance amount that you owe them. The balance amount here is simply = Full amount – (payment made by you). This interest is added to your balance for the next month (at the time of next billing cycle). If you again make a partial payment, the new balance is calculated again and the credit card rate (monthly one) applied to it for calculation of new interest; and it keeps going on and on until you make the full payment.

That’s how credit card rate acts in this vicious circle. Hence, credit card rate is termed as the most important consideration in choosing a credit card.

There are some credit card lenders out there who are trying to scam you. They’ll offer you a good interest rate, wait for you to spend a lot of money, and then suddenly jack up the interest through the roof. Suddenly you’re screwed, with nowhere to go.

Is That Legal?

Well, it shouldn’t be, and in most countries it isn’t. Suddenly increasing your interest rate is generally associated with loan sharking and usury (the practice of lending money at illegally high interest rates) – it isn’t fair to raise the rate once you already owe the money, is it? Unfortunately, in the credit card world of ‘revolving’ debt, the distinction isn’t so clear cut.

In some countries, you might not have a legal leg to stand on – your card issuer can do what they like to you. This is a problem in the USA especially, where credit cards are based in states like Delaware that have ineffective usury laws.

What Can Trigger a Rate Rise?

Credit card companies do give reasons for any rises, and some of them are valid. Many, though, can seem quite unfair – a lot more sharing of information goes on in the financial industry than you’d expect. Here are some examples of things that can saddle you with the extra-high ‘penalty rate’:

Paying late. If you don’t pay your bills on time, the company seems quite justified in taking away your good rate. After all, you’ve broken the rules of your contract.

Spending on other cards. You might think that one card issuer won’t know what you’re doing with a competitor’s card, but you’d be wrong. Acting oddly or badly with one card can cause others to get jumpy and raise your rates.

Defaulting on another bill. Any bill you don’t pay – whether it’s for another card or for your electricity – gets put on your credit record. The next time your issuer check your credit rating (they usually do it quarterly), they’ll spot it and want to raise your rate.

Bouncing cheques. Again, this goes on your record, and spooks card companies.

Remember that your rate can usually rise at any time for any reason – most credit card contracts only require the lender to give you about two weeks’ notice. Plus, in general, when one of your cards’ rates go up, they’ll all go up. That’s another good reason to be scared of credit cards, and not to have too many.

What Can You Do If It Happens?

If you rate suddenly jumps up, the first thing you should do is try to cancel the card and move the balance elsewhere. If you can’t do that for whatever reason, then contact your local consumer protection agencies. The next step after that, really, is to get a lawyer.

It will also pay to make as much noise as you can. Complain to the company and the regulator by post. Contact your local newspaper and radio station. Make enough trouble that it would be easier for them to do the right thing just to shut you up. The squeaky wheel gets the oil.

Low interest credit cards

A lot of people just look at low interest credit cards when they are looking to get a credit card for themselves. The credit card suppliers too advertise low interest credit cards more that any other kind of credit cards. However, should low interest credit cards be the only ones on your list when you are hunting for a credit card? Probably not. For some people, interest rate or the APR is probably the most important thing to look for when selecting a credit card. However, that doesn’t hold good for everyone. Low interest credit cards are good and should surely be on your list, but APR is not the only thing to look for.

Let’s start with understanding what an APR (annual percentage rate) is and where its importance lies. APR is simply the interest rate that is used to calculate interest on the balance in your credit account with the credit card supplier. There is no interest charge if you make the full payment of your credit card bill (by the due date). However, in case of a partial payment, you will need to pay an interest on whatever you owe the credit card supplier. The APR is backward calculated to get a monthly rate and the same is applied on your balance to calculate the interest for the applicable period.

That means, people who are not sure about being able to pay the full amount, every time, should surely look for low interest credit cards. A low interest credit card helps in reducing your total outgo by curtailing the interest you pay on your balance. So, low interest credit cards help in slowing down the rate at which your credit card debt builds up. Thus low interest credit cards are surely important for a particular group of people, as stated above.

Besides this group, there are others who don’t really need low interest credit cards. These people are capable of (and intend to) pay off their credit card bill in full every month. Their purpose in using a credit card is convenience and other benefits associated with the credit cards. So, be it low interest credit cards or high interest ones; it really doesn’t matter for them.

So the need for low interest credit cards is more felt by a particular group of people. However, even if you go for a low interest credit card, you need to pit the various low interest credit cards against each other (vis-à-vis the other benefits they offer) and then select the low interest credit card that is best suited to your needs.

So, first you need to evaluate whether you need to go only for low interest credit cards and then select the low interest credit card that fulfils your needs. After all, you don’t go hunting for a credit card everyday.

When you’re paying back debts, a little strategy can make a difference of hundreds or even thousands of dollars. The best strategy is simple, but effective.

List Your Debts.

Write down a list of every debt you have, how much it is, and what the interest rate is. You might have trouble finding this information, but it’s worth getting it all together in one place and write it down. You can’t manage your situation strategically if you don’t even know it, can you?

Remember to include your credit cards (with the different rates and balances for purchases and cash advances), other cards, loans, mortgages, and even money you’ve borrowed from friends and family. Every bit of debt counts, and you’re trying to get it down to absolute zero.

Bad Debts and Good Debts.

Go through your debts and mark them ‘good’ or ‘bad’. You might think this is odd, but some kinds of debt are nowhere near as bad as others. A mortgage, for example, is an investment in a house, paid over a fixed term – there’s no real risk of paying a ridiculous amount of interest or never getting it paid off, like you could with a credit card.

Good debts: mortgages, student loans, car loans.
Bad debts: credit cards, store cards.

As a rule, good debts are for a fixed amount of time and allow you to buy something valuable that you cannot afford, while bad debts are ‘revolving’ and are just used instead of cash.

Time to Prioritise.

Cross your good debts off your list, for now – you shouldn’t think about paying them off more quickly until you’ve got all your bad debts out of the way.

Now, arrange your debts in order of interest rate, with the highest interest rate at the top. The chances are that the debt at the top will be a store card or credit card, which could have a really huge interest rate. Try to transfer as much money as you can from the high-interest cards down the list to the lower-interest ones.

Once you’ve done that, focus all your energy on repaying the new top debt. Pay the minimum on everything else, and throw as much money as you can find at the problem. If you have any non-essential monthly commitments, consider cancelling them for a while, and putting that money towards your payments. Stop saving, just for a while. Try keeping track of where your money goes, just for a month – you might find that you’re spending loads on something you don’t even want or need.

Do your best to give up any expensive habits you might have. You’ll be shocked how fast your debts can go down if you put the money you’d usually spent on smoking, drinking or gambling towards them! I’m not trying to spoil your fun here. You’re just making some small sacrifices for a while, and your life will be so much better for it in the long run.

You have to be aggressive against that top debt, and determined to defeat it. This is a war, you’re on the attack, and you want to win against your debt. Don’t you?