Do You Know What Factors Affect YOUR Credit Card Interest Rate?

(This is a guest article by Mirsad Hasic*)

Did you know that the average American family has an average of $5,219 credit card debt with an average interest of 17-20 percent? Yes, very disturbing indeed considering that the interest rate is usurious in every way possible. And with such a high interest rate, it will be tough to get out of debt and shape up one's financial issues.

Keep in mind that the credit card interest rate is the principal means by which the issuers generate revenue from letting the holders borrow the former's money for purchases bought with the credit card. In effect, the holder is paying a fee for the privilege of borrowing money, which will take time to accumulate if not for the credit card issued by the bank.

Since the bank is taking a risk in letting the holder borrow its money, the interest rate is based on how much the former believes the latter is a credit risk. Thus, if you are seen as a high credit risk by the bank, your interest rate will be higher but if you are a low credit risk, your interest rate will similarly be lower.

This is the rationale behind the statements that the interest rate you pay for the credit card is largely under your control and that the quickest way to secure a low interest rate is to become a low-risk holder.

Personal Credit History

Probably the most important factor in the determination of credit card interest rate is the personal credit history of the applicant. With the sophisticated information-gathering techniques used by national and international credit bureau reporting agencies, your personal credit history can be tracked for as long as 10 years ago. Missed payments on utility bills, defaults on loan amortizations for any kind of asset, foreclosures on the house, less than minimum payments on credit cards, and bankruptcy filings on one hand and almost-perfect payment history on the other hand all show up on these credit reports.

Your credit history shows how high or how low a credit risk you will be to the bank. If you have a spotty credit history, the interest rate will be higher. If you have a spotless credit history, the interest rate will be competitive so much so that it will be almost like borrowing the money interest-free. This is not a form of discrimination since any investor will want to protect his interests and that includes banks lending money to the holders.

Length of Credit Profile

The length of time relative to the credit account also comes into play when determining the credit card interest rate. If you have long held credit cards and you have kept them current, chances are that the interest rate will be lower. For new cardholders, the other factors will be considered more than the length of the credit account.

Percentage of Credit Used

But just because you are on top of your various kinds of credits from utilities and mortgages to credit cards does not necessarily mean that the interest rate will be lower. The bank will look into the percentage of available credit being used at the time you have applied for the new credit card account.

As a general rule, banks consider individuals and households using more than 30 percent of their available credit as higher credit risks than those who use a lesser percentage of their available credit. Borrow within your available credit to avoid being imposed higher interest rates on the new credit cards being issued.

Debt-to-Income Ratio

But the banks will not only look at your financial past. Your present and future finances will also be assessed to determine your credit worthiness. First, you will be asked about your current financial status specifically your debt-to-income ratio. You may even be asked for audited financial statements both for your personal and business accounts to provide the bank with an objective perspective into how well you are doing at present in terms of finance. Jobs, businesses and other economic activities will be asked.

Second, you may have to justify your credit card application with proof of a future flow of money into your possession. It can be an inheritance, income from government bonds and other verifiable sources of revenue. Your goal is to show the bank that you have the financial means to pay your credit card balances for their full amounts in the future.

Bank Promotions

Many credit card issuers offer promotional interest rates to attract customers to take out credit cards for their own use. Thus, you will see banks offering a zero percent rate for the first 6 months of use, which you will be attracted to when other issuers are not doing so.

However, you must be aware that the good times cannot last as long as you want it to. The banks will raise the interest rates to bring them in line with their profit goals. You may even be imposed an additional interest rate, no matter how miniscule it may look on paper, when you have been deemed a higher credit risk than was previously thought.

Economic Factors

And then there's the economy to take note of. Along with the bank policies on promotions, the economy is one of the uncontrollable factors that determine your interest rate.

Banks usually base their credit card interest rates on the prime rate, which represents the most favorable rate given to the individuals with the highest credit worthiness. (In other words, these are the holders with the lowest credit risk). The prime rate, in turn, is based on the federal funds rate, which is the rate at which banks charge other banks for credit.

If you want a lower interest rate, be a low credit risk. You have to pay your bills, amortizations and other payables on time; provide for proof of stable finances for the present and the future; and just generally be somebody whom the banks can trust with paying back their money. Even in these tough times, all that is possible.

*About the author: This article was contributed by Mirsad Hasic. Mirsad is the editor of best credit card deals, a consumer oriented site where you will learn how to pick a credit card that suits your needs and also get valuable tips and strategies on credit card debt relief.

*Image Credit: Photograph by Stargazer95050 [via Flickr Creative Commons]

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1 Comment:

Jenna said...

The community does a lot of interesting case studies on how certain things can change your credit score. You might want to check it out.