Credit Card Basics: The Interest Rate

In the hands of a disciplined and diligent spender a credit card can be a very useful financial tool but in the hands of someone that is easily tempted by the alluring siren signal of the impulse buy it is often a pathway to disaster. The old saying goes that the road to hell is paved with good intentions and in hindsight one might argue that this saying was created purely to apply to credit cards. In order to understand credit cards one must understand the basics that underlie a lot of credit card business. One of these basics is the interest rate and the rest of this article will explain in more detail exactly what an interest rate is.

Interest Rates

The philosophy of the interest rate is an interesting one and actually has to do with the history behind the credit card itself. Credit cards in their modern form have really only been around for a few decades and before their advent the only way for a person to borrow money was to take out a conventional loan from the bank. This loan required collateral and if the person was not able to pay the loan back the bank simply liquidated the collateral and used the funds from the liquidation to cover the outstanding amount of the debt. It was a simple arrangement.

With credit cards however there is no collateral put up against the money borrowed with them (also known as an unsecured loan in financial jargonese) and for that reason banks and financial institutions feel that they need some way to make up for this. An increased risk (lack of collateral) requires an increased reward and this increased reward in the form of credit cards is a higher interest rate. Both you and the credit card company take risks in signing credit card agreements and understanding the philosophy behind the higher interest rates is a key step towards becoming a good consumer.

Usage

The usage of interest rates varies depending on the type of credit card and the features that come with it. Typical interest rates will be in the 15% to 20% range and will be compounded monthly at a rate of 1/12 the annual rate. This is a very standard deal for credit cards and if you are able to get a permanent deal that has an interest rate of less than 15% then it is definitely a deal that is worth taking a second look at.

Interest rates are quite often combined with fees in order to allow the companies to extract more money from their customers. Keep in mind that a credit card company is extremely bottom line orientated and that a number of the things they do to get money from their customers are not always readily apparent. Read the fine print and understand the full agreement before you commit to anything.

Article correct at its author date: April 2007. Copyright Virtual Office Space, Any unauthorised reproduction of this article will be prosecuted to the full extent of the law. Credit Cards Australia.

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