Credit Cards: Fixed Rate vs. Variable APR

Understanding Fixed Rate vs. Variable APR

The interest rate on credit cards is considerably higher compared to other forms of debt. If you’ve taken a look at your cardholders agreement you’ve probably noticed that there’s multiple interest rates – so what do they mean?

In today’s consumer credit world cards often carry a fixed interest rate vs. a variable one.

It’s pretty much what you think it means. With a fixed rate, the interest rate on the card won’t change vs. the variable rate which means it’s subject to change, based on your ability to make payments. With a variable interest card, the rate can change often but the issuer must let you know how often it is likely to change.

What is APR?

Annual percentage rate (APR) is the cost of credit as indicated by a yearly (fixed or variable) interest rate. This rate and the periodic rate (the APR expressed as a daily or monthly factor) must be disclosed to you before you become obligated on the card.

When you apply for a credit card you should understand how long you will be able to take advantage of the low APR the company is offering. Many times this low APR is used as an incentive to get you to apply and use their card and then raising the APR in just a few months up to one year.

The APR that you’ll be charged can be calculated fairly simply. Take the percentage of your APR, and then divide it by 12 months. This is the percentage you will be charged monthly. Now, take your outstanding balance and multiply by this percentage and you will learn what your finance charge will be for that month.

Example: APR on a credit card is 24.99-percent, divided by 12 months and you’ll get 2.08-percent per month interest.

How to Calculate Your Outstanding Balance

Each credit card company used their own method to calculate your outstanding balance, which they then use to determine what your monthly payment should be. The most popular methods are below, with the ones with the lowest finance charges first and so forth.

Avg. daily balance excluding new purchases: This one can be confusing. This calculates your balance daily and then divides it by the number of days in your billing cycle. New purchases are not included but payments and credits are included.

Avg. daily balance including new purchases: This is pretty much the same as average daily balance except you all new purchases are also included.

Adjusted balance: An adjusted balance is the balance that you have at the beginning of your billing cycle with all your payments and credits made during the period.

Previous balance: This is the balance that you have at the beginning of your billing cycle. It does not include new purchases nor reduce any of your payments during the billing period.

Two-cycle avg. daily balance excluding new purchases: With this method the average daily balance of two consecutive billing cycles are calculated and then divided by the number of days in the two cycles and it does not include any new purchases. However, any purchases made during the first cycle can incur interest on the second cycle on the purchase for both cycles if the balance was not paid by the end of the first cycle.

Two-cycle average daily balance including new purchases: The same as above, with the exception, that all new purchases are included.

Balance Transfer Interest Rates

Perhaps you’re not currently using your credit card, but you want to minimize the finance charge on your existing balance. One way to do so is to transfer your balance periodically to a new card with a low introductory “teaser” rate of interest.

In some cases interest on the first 12-18 months may be 0%. However, once the intro balance transfer APR offer is over, a new APR will apply and start charging you a variable rate.

Here’s a few things to look out for with balance transfers.

  • A low introductory interest rate that applies only for a very short period of time.
  • A low interest rate on new purchases, but a higher interest rate on balance transfers.
  • Balance transfer fees, particularly with uncapped amounts are calculated as a percentage of the balance transferred.
  • Termination fees and retroactive interest charges levied if you decide to surf the next wave and close the account or transfer the balance to another card before a specified time period has elapsed.

When you transfer a balance from an existing card to a new one, it’s a good idea to close the account you’re leaving. By doing so, you won’t be tempted to use the card again (at a higher rate of interest once the introductory offer period has expired), and you’ll minimize the potential for fraudulent use or identity theft. What’s more, if you do not close those accounts and later try to transfer your balance again, a new card issuer might turn down your application, afraid you’ll incur too much debt by running up new balances on dormant, but open, credit card accounts.

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