Credit cards charge a fee on balances that you carry beyond the grace period. They calculate this fee using an interest rate that must be disclosed to you before you agree to accept the credit card. There are two basic types of interest rates: fixed interest rates and variable interest rates.
What is a Fixed Interest Rate?
A fixed interest rate doesn’t necessarily remain fixed. In fact, credit card issuers are allowed to change a fixed interest rate, but only under certain circumstances. Right now, credit card issuers are required to give cardholders are 45-day advance notice before raising a fixed interest rate. Card issuers are also required to give cardholders the opportunity to opt-out of the interest rate increase and allow them to repay their balance at the old interest rate.
Starting February 22, 2010, new credit card regulations limit fixed interest rates increases to certain circumstances.
- If you are more than 60 days late on your credit card payment
- You had a promotional rate that has ended
- You’ve just completed a debt management program
- You have a variable interest rate and the underlying interest rate has changed
After the new credit card rules go into effect, fixed interest rates can’t increase within the first year of the account’s opening unless it’s for one of the reasons listed above.
What’s Different About a Variable Interest Rate?
A variable interest rate is tied to another interest rate, usually one that moves with the economy. The variable interest rate is a certain number of percentage points above the index rate. (The difference between the two rates is called a margin.) For example, the variable interest rate on your credit card might be prime + 13.79%. In that case, the margin, 13.79%, is added to whatever the prime rate is at the time to come up with your interest rate. Prime is currently 3.25%, making your interest rate 17.04%.
Your variable interest rate will go up and down as the underlying rate goes up and down. Credit card issuers don’t have to send you an advance notice when your variable interest rate goes up because the underlying rate has gone up, so you won’t know if your interest rate has changed unless you pay attention to your credit card billing statement. If your credit card issuer increases the margin portion of your variable interest rate, the fixed interest rate increase rules apply. Your card issuer will be required to notify you in advance of the chance, giving you the chance to opt-out.
Is a Fixed Rate Better Than a variable Rate?
The primary benefit of a fixed interest rate is the requirement of advance increase and the ability to opt-out of an interest rate increase. Opt-outs may save a few dollars in interest charges, but they can hurt your credit. With variable interest rates, you can find out when your interest rate will be increasing if you pay attention to news about when the Feds are increasing interest rates.
You can avoid paying interest completely by paying your balance in full at the end of each month. That way, it won’t matter whether your interest rate is fixed or variable.