Why Do Credit Cards Charge High Interest Rates?
One of the biggest consumer complaints about credit cards is the high interest that is charged by the issuer. Even low interest cards have much higher interest rates than most other loans. Why do credit cards charge such high interest rates? Is there anything you can do to avoid them?
How Issuers Assign Interest Rates
It is risky for a bank to grant any type of loan because there is always the chance you will not pay back the money. So banks assign a certain interest rate based upon the financial risk of that loan.
Some loans are secured, like one on your car. If you don’t make your car payments for several months, chances are a wrecker will come into your parking lot and tow away your vehicle. The bank repossesses your car because it was a secured loan. The bank is putting all the money up front for your car and you are paying them back, one month at a time. If you fail to make some payments, they’ll simply take the car back from you. The same theory applies to your home loan.
But credit cards are unsecured loans. Banks do not ask you to put up any collateral in return for a loan. If you don’t pay back the loan on your credit card, the bank cannot repossess that stereo system you purchased or that new outfit you are wearing. So the loan that a credit card issuer makes is a much greater risk than a secured loan. Hence, the interest rate is significantly higher.
A second reason interest rates are high on credit cards is that these interest rates are really determined by what the market will bear. Credit card companies are not bound to any specific limits with their interest rates. Thus, they can essentially charge whatever they want, as long as their rate is competitive with other credit card companies.
Finally, interest rates are high on credit cards to encourage you to make your payments on time. The longer you let your account sit, the more interest penalties you will have to pay. If you feel the pressure of your APR weighing on you, chances are you will be more inclined to make your payments back to the issuer.
Why Is My Interest Rate So High?
If you have a higher interest rate on your credit card than most people, it is most likely due to your credit score. Low credit scores often lead to higher interest rates. There is a higher risk to the credit card company in giving you that unsecured loan. The fact that you have a low credit score may indicate that you have had some trouble managing money in the past. This may not entirely be your fault but the credit card company has chosen not to give you that short-term loan without being compensated with a higher rate of return–hence, a higher interest rate. This high interest rate indicates that the issuer feels you are less likely to make payments on your account than someone would be with a good credit score.
Another reason may be that you signed up for a card that had a high rate from the outset. Did you look into that before applying? Some people do not do a thorough job of researching the credit card’s terms and conditions to learn the details of the card. Others see that cards offer a range of interest rates, such as 12.99% to 20.99%, and assume they will be assigned the lower rate. That is not always the case. It pays to fully research all the details of each card you are considering.
How to Avoid High Interest Rates
If you don’t want to pay the high interest rates associated with your credit card, you could go in search of a card with lower interest rates. The challenge is that you will need to have good credit to qualify for one with a lower APR.
Remember this: you don’t have to pay any interest if you don’t have an outstanding balance on your credit card. That doesn’t mean you have to stop using your card. It just means that you have to pay off your balance before the due date each month. In an ideal scenario, you will already have the money for a transaction in cash or in your bank account. In this case, you are using the credit card for convenience, so you don’t have to carry cash. But you’ll also earn some rewards and build your credit along the way.
If you manage your credit card well for a period of time, your credit card provider may lower your interest rate or increase your credit limit.