An annual percentage rate (APR), also referred to as an interest rate, is the amount of interest that an individual is charged on credit card purchases they make. Credit card companies set the annual percentage rate.
Banks utilize the average prime rate to determine how much interest will be charged on loans. The Wall Street Journal calculates the average prime rate for banks and credit card companies rather than the bank or credit card company.
If an interest rate is higher, an individual will be required to pay more in interest payments over the term of the loan. For example, suppose an individual borrows $15,000 at a fixed interest rate of 5% for 48 months on a vehicle loan.
Over the life of that loan, the individual will pay a total of $1,581 in interest. If an individual borrows the same amount for the same period with a fixed rate of 6%, they will pay $1,909 in interest, or $328 more than the previous example.
If an individual borrows that same amount at 7% fixed interest for the same amount of time, they will pay $2,241 in interest, or $660 more than at the 5% rate. It is important to note that these amounts do not include any fees which may be associated with the loan.
For example, suppose an individual borrows $200,000 for their mortgage at a 3% fixed interest rate for 15 years. Over the life of this loan, an individual will pay $248,609.39.
If the mortgage rate is 5%, the borrower will pay $284,685.71. That is a difference of more than $36,000 between the two interest rates.
The following example applies to a credit card. If an individual has a $3,000 balance at a 15% interest rate and they pay the amount off in two years making $145.46 in monthly payments, they will pay $491.04 in interest.
In addition, if an individual does not pay their credit card balance in full each month, the interest will accrue on top of the amount that is charged to the card, increasing their debt. This may affect their debt-to-credit utilization ratio.
This ratio is the amount of credit that an individual is using compared to the total amount of credit they have. If this ratio is high, it may negatively affect their credit score.
Yes, there are different types of interest rates that an individual may consider when choosing a credit card, including:
The primary reason an individual’s interest rate may increase is that their lender may hand them a penalty rate, or an increase in their interest rate on their credit card. This may occur when an individual has proven to be a risky investment for the lender, meaning they are unsure whether the borrower will pay back all of the money they own.
There are several factors which may make an individual appear to be a risky investment. This includes making late payments or not making payments at all, which will likely result in the credit card company increasing the individual’s APR.
An individual’s lender also has access to their credit report and may consider increasing their APR if it notices that they have recently defaulted on a loan. A lender may also increase an individual’s interest rate if they have proven to be a risky investment.
Lenders, however, are not legally required to have a reason to raise a borrower’s APR.
Floating interest rates are adjustable interest rates on debt instruments such as loans or mortgages. A floating interest rate will change depending on a market rate that is outside of a lender’s control.
Typically, the interest rate is reassessed, or changed, every 1, 3, 6, or 12 months, depending on the period that was agreed upon between the lender and the borrower. One commonly-used market rate is the London Interbank Offered Rate.
For example, if an individual obtained a 2% floating interest rate in January where a loan is reassessed every 3 months, their interest rate may be at 5% in April and change to 1% in July.
Fixed rate loans, on the other hand, have an interest rate that stays the same throughout the life of the debt instrument. For example, if an individual obtained a 5 year vehicle loan with an interest rate of 2.99%, the interest rate will remain fixed at 2.99% for those 5 years and will not change.
Depending upon when an individual obtained their interest rate, a floating interest rate may be a better deal. With a floating interest rate, however, an individual bears the risk of the interest rate increasing in the future.
Some debts, however, such as mortgages, have interest rate caps. This means there is a limit on the maximum interest rate or the maximum change that is allowed.
For example, suppose an individual obtained a mortgage with a 5% floating interest rate and a 2% maximum interest rate cap. The borrower will never have to pay anything over a 7% interest rate even if the current market rate is 8%.
However, the borrower must pay at least 3% interest rate even if the current rate is lowered to 1%.
Floating interest rates may increase to the point where a borrower is no longer able to repay the loan. If this occurs, a borrower may request a loan modification.
A loan modification may:
An individual’s monthly payment goes towards interest instead of paying off their balance when they are stuck in a cycle of paying off large balances with high APRs. It may take an individual many years to pay off a high-interest credit card.
It may be helpful for an individual to hire a debt relief company if their balances are overwhelming. A credit counseling service is one example.
These services have trained staff members who can walk an individual through how to pay off their credit cards as well as how to improve their credit score. Interest rates have a big influence on consumer debt.
The higher the APR on an individual’s credit card or loan, the higher their balance will be and the longer it will take to pay that balance off. If an individual wants to pay off their loans faster, they can reduce their APR or increase their monthly payment.
If an individual does not qualify for a lower APR or they do no have the ability to make a larger monthly payment, debt relief companies, such as credit counseling agencies, may be able to assist an individual with catching up on their debts and creating a payoff plan.
An attorney who is experienced with loans and mortgages can assist you with understanding and utilizing floating interest rates. A mortgage attorney can provide you with advice if you are considering making this large type of purchase.
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