Understanding credit cards interest rates

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Understanding credit cards interest rates

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The interest rates charged by credit card companies is dependent on certain factors; the credit card limit, cash withdrawn or purchases made and also the grace period all help to influence such. Before understanding how the credit card interest rates get calculated there is one major difference that needs to be understood before proceeding towards the other factors on which the credit card interest rates depend.

APR and EAR

The APR charged by the credit card companies is misunderstood to be the actual interest that is charged on the remaining balance of the account. This concept is actually false. An APR is actually an approximation of the present interest rate or what it might stand to in the near future. Under stable market conditions an APR is a suggestion of the Effective Annual Rate or EAR. But since the market remains volatile therefore this cannot be considered to be the actual calculation on which the EAR will be based. The APR and the EAR might differ by the end of the financial year.

The EAR on the other hand does not include interest rate changes that might occur due to late payment of fees, balance transfers or introductory offers as granted to the customers. The calculation involved in computing the EAR is complicated and therefore adds to the confusion regarding the calculation of the interest rate charges.

Factors that decide the interest rate

The most important factor that sets up the credit cards interest rates is the corresponding interest rate that is charged by the Federal Reserve of the country, the credit worthiness of the customer that ascertains how quickly a customer can repay his credit bills and his credit history and finally how does the issuer of the credit card project the rate of inflation in future.

If the above factors are responsible for deciding the interest rate charged on a credit card then low interest rate charged by the Federal Reserve Bank, a good credit history of the customer and also stable market rates with balanced inflation will lead to lower calculation of interest rates.

The other important factor that decides the interest rates on credit cards is the charges that get levied due to late payment. All credit card companies have the right to increase their interest rates if a customer fails to pay a credit bill on time. This also justifies the other credit card companies to raise their interest rates.

Balance transfer is another reason that affects credit card interest rates. Usually lower interest rates are charged as an introductory offer. Once the grace period gets over the APR increases and is bought to its original rates on the remaining balance.

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