Although the economy drives interest rates for banks, the average interest rate is strangely detached from economic reality. There is no other explanation for the current rates in an economy with the lowest interest seen in many years.
Credit lenders claim to base their rates on many factors but have been unwilling to reveal what formula they use. That may be due to changing formulas.
Credit History
One factor in setting an interest rate on a new account is the credit history of the consumer. The higher your credit score, the more likely it is that you will be given a favorable interest rate on your new account.
That has long been an accepted financial fact in the U.S. but recent developments in the credit industry have revealed a new pattern.
Financial institutions are “for profit” and there is nothing wrong with that in a capitalist society. The problem for credit card issuers has been the need to consistently show increasing profits quarter after quarter.
For many years this was not a problem as consumers were becoming accustomed to the use of credit and adopting it for everyday purchases.
People began to carry multiple credit cards and to use credit for daily purchases as well as for special items or vacations.
Other Ways To Increase Profits
As the requests for new credit cards peaked, credit issuers looked for other ways to increase profits. Fees for late payments and account over limit charges were doubled and then tripled and other hidden fees were added.
Consumers began to complain loudly about the fees being added to account balances. The next line of profit was interest rates.
The most unusual aspect of the credit card market is the ability to raise interest rates for no apparent reason. Consumers receive a small notice that is almost impossible to understand and doesn’t seem to be important.
This notice is often included with a monthly bill or with a special offer from the credit issuer. The notice is actually an announcement that the interest rate on that account is going to be higher. The consumer has two choices when this happens.
Two Choices
If you receive such a notice, you can continue using the card and accept the higher interest charges. If you are not willing to pay the higher rate, call the company and close your account!
If you do that you may not use the account for purchases but you are allowed to pay off the account under the previous interest rate terms and payment terms.
The failure of credit card companies to disclose why interest rates are being raised on accounts has angered many consumer groups.
New credit card regulations that take effect in 2010 will disallow the practice of arbitrarily raising interest rates. Although credit companies have complained loudly about the new laws, they must admit the problem began with them.
Interest Creep
One of the major complaints was about a practice known as interest creep. Thousands of card holders noticed that each month their average interest rate was rising by 1/8 to 1/4 percentage point.
There was no explanation and the credit companies claimed the rising interest was due to information from credit bureaus. Consumers checking with credit bureaus found no changes there.
It has long been a perception that only consumers with bad credit have the highest average interest rate. That is no longer true as even card holders with very good credit have seen their interest rates skyrocket in the past year.
Credit companies are positioning themselves for the new laws that will not allow these predatory practices and they are blunt in telling customers that positioning accounts is what is happening.
The Initial Rate is Not The Problem
The current problem with credit card interest is not the initial rate which may be fairly reasonable. It is the practice of raising rates with little notice and no reason that has led to serious financial difficulty for many credit account holders.
If the interest rate on your account is changed, that change applies to all of the balance you carry on that account.
Currently, the customer with the highest credit ratings will have 12% interest rates. The average interest rate (for those with good credit) is 16-18% for a new account.
This may seem high but the real danger is in having the interest rates raised to over 30% and this is being done by almost all credit lenders at this time.
What Can You Do To Avoid This Pitfall?
The best advice to follow is to choose the lowest interest rate credit card you can qualify for and read everything sent to you by that credit card company.
If you have a good credit rating you can transfer a balance to a new card at a more favorable interest rate if your lender raises the interest rate on your account with little notice.
I would also like to recommend you our guide for debt elimination even if you are debt free (at the moment).
