How Does Your Credit Card Interest Rate Work?

One of the more confusing and frustrating parts of having a credit card is the interest rate. How can you get a lower one? How does it actually work?

APR and How Interest is Applied

If you've ever applied for a credit card then you have certainly seen literature touting an APR. APR stands for 'annual percentage rate' or the rate of interest you will be charged over the course of a year. Since you are never going to be charged once a year you have to divide that by 365 for the daily rate or 12 for the monthly rate.

For most our interest is calculated on a daily basis - what that means is that the number you get when you divide your APR by 365 is applied to the balance you are carrying during that day. So if you have an interest rate of 16 percent then your daily rate would be 0.043%. Interest is applied to the balance every day and compounded into a monthly charge. This may slightly inflate your APR if your balance fluctuates a lot throughout the year.

How Interest is Determined

There are a few variables that factor in when a credit company is determining your interest rate. The first is the prime rate which is the national baseline percentage that fluctuates as a response to the economy. Though your APR can be predetermined in most cases it can fluctuate a few points if the prime rate changes drastically.

The second factor is the company itself. Some companies offer lower rates but higher fees, some have promotional offers to attract new customers and some have card varieties that feature different rates and amenities.

The final factor is your credit history and score. If you have great credit and a high score you will get a much lower rate and the opposite for those with poor scores. The lower APRs tend to fall closer to 13 percent and the higher ones up to 23 percent - that's quite a difference if you factor in the balance you tend to carry.

How To Lower It

Lowering your interest rate is all about improving your credit history and shopping around. Settling on the first card you see isn't a sound strategy when there is probably a better one out there. Look around to see what credit cards are offering what promotions and evaluate them based on your needs.

Improving your credit score is also a way to lower a future interest rate. Making on-time payments and lowering balances can both aid in boosting your score in the long run.

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