An interest rate is a charge or fee to borrow money. The higher it is, the more you pay. Interest rates vary based on current available rates, credit scores and other risk factors.
What Is an Interest Rate?
An interest rate is the rate paid to use money. If you borrow money, in the form of a credit card, mortgage or personal loan, the lender will state the interest rate. Most lenders express this in the form of an annual percentage of the principal paid. To calculate it, divide the amount of interest by the amount of principal. If a lender charges seven percent on a loan of $1000, the consumer will pay $70 to borrow those funds over the course of a year.
Numerous factors affect the rate. It can change because of inflation, for example. The Federal Reserve's monetary policies also affect this charge. The index rate, or the rate the federal government sets, is not what most people pay, but rather what banks pay to borrow money to lend. Nearly all banks charge a fee on top of this "prime" rate.
How Credit Rating Affects Your Interest Rate
Your credit rating is a statistical estimate of whether or not you will pay back your future loans. Lenders use your past financial history to determine how much risk you are. If you default on a loan or do not pay your bills on time, your credit rating goes down. If you have poor credit, you will find it more difficult to get loans, and your credit card interest rate may rise.
Specifically, lenders want to ensure that the person who borrows from the lender will repay the loan. Those who have good credit scores generally pay less in interest. Those who have bad credit scores pay more in interest. If you have the following bad credit notations on your report, lenders will charge you a higher rate of interest because you are considered more of a risk.
- You make payments late - This indicates you may be struggling to repay what you owe.
- You use credit heavily and have maxed your credit limits - This indicates you may be desperate to borrow more money and are living outside of your financial means.
- You have no credit history - You may be new at borrowing which means you do not have positive credit experiences to justify giving you a loan.
- You have collection accounts - Your previous financial mistakes, including public records, may indicate you struggle to make good financial decisions.
- In these situations credit card companies are likely to charge more in interest to give you a loan. If your credit score is very low, the lender may decide not to lend to you.
Lenders must provide you with accurate interest rate charges prior to opening the account. To find the most recent data on interest rates, visit Bankrate.com or CreditCards.com. In addition, each lender will feature rate information for available credit cards on their website.
Variable Rate Credit Cards
Variable rate credit cards mean that your credit card company can increase or decrease your interest charge. It usually happens when the Federal Reserve changes interest rates in general. Though lenders must provide notice of such changes, and why they are occurring, you could end up paying more over time if you carry debt month-to-month.
Special Interest Rate Considerations
Some credit cards offer special interest rate offers. A company may offer an introductory period of zero percent interest, for example. In this particular offer, you will not pay interest during the initial period you have the account open. However, interest can still accumulate and the lender may apply it if you still have a balance after a set amount of time.
It is also important to know that rates can go up. Interest rates are often higher for cash advances and balance transfers, aside from just purchase charges. You may pay a penalty interest rate for a period of time if you fail to make payments on time or exceed your credit limit.
If you improve your credit score and personal credit history, contact your lender to ask for a lower interest rate. If you cannot get a lower rate, stop using that card and look for a lower interest rate card.