How do variable credit card rates work?

variable rate credit cardsVariable interest rate credit cards are subject to change once each 12-month period. The interest rate is tied to an index value, usually a stable domestic or international banking rate. For most American credit cards, this value is the U.S. bank prime lending rate, currently at 3.25%.

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A margin or rate mark-up is added to the raw index value to create the annual percentage rate or APR at which the account will be charged over the next year. For instance if a bank offers a starting interest rate of 9.99% on its new credit card, and uses the prime lending rate as an index value, the margin is 6.74.

If the starting rate is 12.99%, the mark-up is 9.74. Index values and margins must be clearly delineated in the credit card contract agreement and may not be changed. Card agreements must also give examples, such as those noted above, of how the APR will be computed in the future.

Therefore, in the first example, if the prime lending rate increases to 5% on the next account anniversary date, the new APR will be 5.00 + 6.74, which equals 11.74%. In the second example, the variable interest rate will also increase by 1.75 points to 14.74%! The new rates will remain in effect for the next12 months, even if index values were to drop back sooner.

Another popular banking index is the London interbank rate known by the acronym LIBOR. The LIBOR one year rate is currently at 1.06%. Other index values commonly used are T-Bill rates and other U.S. government securities though these indices are most often associated with variable rate mortgage loans.

Banks Shift to Variable Rate Credit Cards

In the past, credit card companies offering fixed interest rates on their cards were likely to change interest rates at the drop of a hat, often without advance notice to their customers. In fact, credit card interest rates were likely to shoot up with absolutely no warning at all.

Owing in large part to the Credit Card Act of 2009, these unfair lender practices have all but been eliminated. Banks and other credit card issuers must now give consumers at least 45 days notice before imposing any interest rate change.

Unfortunately, these legislative changes early in 2009 led to the disappearance of fixed interest rate credit cards with banks quickly moving to variable rate cards. Variable interest rate credit cards give banks the opportunity to change rates each year to mirror economic changes in the marketplace.

The Credit Card Act limited banks’ ability to change credit card interest rates to once per year, so naturally banks and other credit card issuers wish to make the most of these changes.

variable rate credit cardsWhat Goes Up May Also Come Down

Initially, variable interest rate credit cards could increase over time but there were few provisions for rates to cycle downwards once index values fell back. The banks also established an interest rate floor below which rates charged to consumers could never drop.

In 2010, the Federal Reserve once again raced to the aid of credit cardholders by banning interest rate floors on credit card accounts. This meant that credit card interest rates that increase in the future could also come back down when index values decline.

According to a published Reuters’ news report, while this sounds like a reasonable accommodation, consumers shouldn’t get too excited at the prospect of ever seeing their variable interest rates lower than where they began.

Fixed Rate Credit Cards Still Available for Some Consumers

Fixed rate credit cards are still available for those consumers with serious credit problems or those who may have recently filed for bankruptcy. These fixed rate options are most often secured credit cards, which require deposits from cardholders in order to secure the cards.

These deposits, usually between $200 and $5000, become the cardholders’ available credit limits. The greatest advantage of this type of arrangement is that it allows cardholders to rebuild their credit history.

Secured credit cards also provide the convenience and all the regular benefits and services associated with Visa and MasterCard logo credit cards.

Currently one platinum Visa credit card, from Credit One Bank, offers an unsecured credit card with a fixed rate of 23.99%. This card is also intended for those consumers who may be new to credit or those who have a poor credit history.

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