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To understand how variable interest rate credit cards work, first we must explain how they came about.
For years, the typical credit card had what was known as a fixed interest rate. Credit card companies touted the fixed rate as preferable to variable rates – the fixed rate would not change over a certain period, or so credit card holders were led to believe.
The reality of fixed rates often differed from those claims, however. A credit card company could raise rates at any time, as long as holders were given a 15-day notice before changes were enacted. In essence, fixed rates were not truly “fixed.”
The Credit CARD Act of 2009 changed that. The United States Congress no longer allows banks to change a so-called fixed rate with impunity. In a nutshell, the CARD Act put into place “fixed means fixed” – banks cannot change a fixed rate before a certain amount of time has passed, typically a year.
Since this law went into effect, banks across the nation have been switching cardholders to variable interest rates. Congress had left in place certain allotments to banks that wish to change their credit card interest rates and now, credit card issuers that wish to change rates must use variable interest rates.
But, just what is a variable interest rate?
Variable Interest Rate Credit Cards Explained
Variable interest rate cards are credit cards that calculate their annual percentage rate of interest (APR) by adding a fixed margin to the Prime Rate.
The prime rate is an interest rate determined every quarter based on the Federal Funds Rate. This is the rate that banks must pay to borrow federal money.
The prime rate usually is 3 percentage points above the federal funds rate and can change every quarter. You can read more about the Prime Rate in this article.
Essentially, variable interest rate credit cards charge an APR (or interest rate) that is always equal to the Prime Rate plus their set margin rate.
And, as of February 2010, credit card companies were barred from raising the margin rate on existing accounts. Only the prime rate may be increased or changed on these existing accounts based on fluctuations in the market.
Of course, any new cards you take out may have a higher or lower margin over the Prime Rate than your existing cards.
Where to Find Information About Your Interest Rate
You should be aware that the margin on your variable rates can change if a credit card holder is late with a payment. This is why it is so important to read the fine print for your credit cards in full.
The Truth In Lending Act makes it law that a lender must reveal how your variable rate is determined. Sadly, this information is almost always included in the fine print.
Most cardholders do not read the card agreements in full and can miss important information regarding the interest rates on their credit cards, how often the issuing bank can change interest rates or other charges — and how high rates can go.
It is imperative to read all credit card rates carefully to know exactly what the minimum and maximum rates are that can be charged on the variable rate credit card you are using.
If a high minimum is in place, this indicates that the cardholder will never see any benefit if the federal funds rate drop below a specific point. A low minimum rate is a good starting point for cardholders to look for when considering a new credit card.
To protect against interest rate changes — other than changes to the “default” rate if you make a late payment — customers can consider traditional fixed rate credit cards. But due to the Credit CARD Act of 2009, fixed interest rate cards are becoming the Cryptids of the financial world, elusive and hard to find for anyone but people with the best credit scores.
Can You Protect Yourself Against Interest Rate Hikes?
Credit card issuers are required to provide you with 45-days notice before any change in terms of your card, including an increase in your variable interest rate due to changes on the Prime Rate.
During this 45-day time period, you can choose to "opt-out" of the interest rate increase. If you elect to opt-out, you account will probably be closed, but you will be allowed to repay your outstanding balance at the lower interest rate. To learn more about opting-out of a rate increase, read this article.
If you do not respond to the notification about your interest rate increase, the card issuer can apply the new interest rate to your new purchases as soon as 14 days after the date the notification was sent.
Fortunately, the Prime Rate is currently low. And due to the Credit CARD Act of 2010, existing balances are safe from margin rate increases, making a variable interest rate credit card a safe choice for most people — for now.
Just be sure to read the fine print of your credit card statements, where you’ll find advance notice of interest rate increases. In order to prevent any finance charges, always pay your credit card statement in full by the due date.