Understanding How Interest Rates Work

Interest rates are calculated differently based on the type of debt that you have. When trying to determine interest rates on credit cards, it's important to understand what provisions the lender may have for raising your interest rate if you make a late payment. Keep in mind that most credit cards can raise your interest rates even if the payment you made late was on a different credit card!

Understanding interest rates involves understanding a wide range of terms relating to interest rates, including:

APR: the annual percentage rate, which is the same rate charged when you borrow the money or charge the purchase on a credit card.

Prime Rate: The prime rate is used to calculate interest rates that are charged to the general public on credit cards and loans. The largest banks set the prime rate and give that rate to the customers who have the strongest credit ratings and the best ability to repay the loans. Some credit card lenders set their interest rates as "prime plus 8 percent", so if the prime rate was 7.5 percent, then the interest rate charged would be 15.5 percent. If the prime rate changes, the rate charged to the customer changes.

Fixed Rate: interest rates that are considered "fixed" do not change, although they can be increased if you negate on your agreement to make payments on time.

Penalty Rate: Typically, a contract will indicate how much the penalty rate is. A penalty rate is the amount that can be raised in the event that you are late with your payments. Even if you have made all payments on time with a lender, you can still be subject to a penalty rate if the contract indications a "universal default". A universal default allows one lender to raise the interest rate when you are late with any other lenders. In some cases, a credit card lender may use the universal default clause to raise your interest rates just because you have excessive debt (even if you've been paying on it regularly) or you've defaulted on a loan.

Variable APR / Variable Rate: interest rates that are considered variable can change, depending on the economy or the fluctuations in the prime rate.

Revolving Debt vs Installment Debt

In addition to understanding the various terms related to interest rates, it's also helpful to understand the difference between revolving debt and install debt. Credit cards are considered revolving debt. While there is a maximum limit that you are allowed to borrow, each time you make payments on your credit card, you can "reuse 'that portion of your balance. spend $ 2000, you have $ 3000 available. When you make a payment of $ 1000, your available credit now includes the $ 1000 that you just paid off, and you could use the card for purchases up to $ 4000 at that time. pay your statements. (This is an oversimplified example that does not take into account the portion of a payment that is applied to interest.) Revolving accounts charge the most interest.

Installment debts are loans like mortgages or vehicle loans, as well as personal loans that you may take from a bank. An installment loan is a fixed amount of money that is borrowed over a specific period of time. Your payments each month do not change (unless you happen to have an installment loan with a variable interest rate). Installment debt is easier to budget for, as your monthly payments remain constant.

Source by Debbie Dragon

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