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Rachel Hartman

Rachel Hartman

December 23, 2014

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Understand Credit Card Rates

Search online for a credit card and you’ll find tantalizing features: 0% interest for six months, no annual fees, cash-back offers, and more. Behind those benefits, however, are pages of fine print. One glance at those can be enough to make you vow to pay cash for the rest of your life.

The fine print doesn’t have to be your enemy, though. Understand the terms used in credit-card offers and you’ll be able to find the best plastic to add to your wallet. Here’s a breakdown of 10 common phrases to help you on your quest.

Annual Percentage Rate (APR): This is the cost of credit. (Yup, you didn’t think it was free, did you?) Since credit cards are similar to a loan, you pay interest on the balance you carry. The APR is expressed as an interest rate for the year. To find out the monthly rate, divide the APR by 12 (so if your card comes with 18% APR, your monthly rate is 1.5%). Check the APRs carefully: Cards usually have different rates for purchases, balance transfers, and cash advances.

Average Daily Balance: Companies use this to calculate how much you owe them per month. To find it, they add up the balance you had during each day of the billing period. They divide the total by the number of days in the billing cycle. Say you have an average daily balance of $500. If the APR is 24%, you’ll pay 2% interest on that amount. You’ll be charged $10.00 for that billing period.

Balance Transfer: Some cards tout a 0% balance-transfer option. This means you can move the balance you’re carrying on an existing card to the new one. No interest is charged on the amount for a certain time, usually 6 to 12 months. This gives you a chance to pay off the debt, interest-free.

Cardholder Agreement: All the fine print is stored in this document. You’ll want to check that it contains the card’s interest rate. Also look for an annual fee (if there is one). The Federal Reserve requires companies to include how the minimum payment is calculated, and what your rights as a consumer are. If there are changes to the agreement, the credit-card issuer must let you know in written form.

Cash Back: This feature rewards you for swiping your card. When you purchase an item, a certain percentage of the amount spent is given back to you. So if the card offers 5% cash back, and you spend $300, you’ll rack up $15 just for using the card. Sounds great, right? It can be. But most cash-back cards have high interest rates, so it’s only worth it if you intend to pay your balance in full each month. Also, look for phrases like “up to 5%.” You might not earn a full 5% cash back until you reach certain requirements.

Grace Period: This is your “interest-free” zone. After you make a purchase, you have a certain time period to pay off the balance before interest is charged. Most credit cards have grace periods that last between 20 and 30 days. Some cards come without a grace period—avoid these if you can.

Minimum Payment: If you carry a balance, you’ll have to pay at least part of it off each month. Your credit-card statement will list the amount you need to pay. The minimum payment is usually 2–4% of the outstanding balance.

Penalty Fees: If you do not make a minimum payment on time, you’ll end up with a late fee. This can be costly, and can also lead to a higher APR. To avoid trouble, consider having payments automatically taken from your checking account.

Prime Rate: This is the interest rate that banks use when lending to their most trusted customers. Many credit-card interest rates are tied to the prime rate.

Variable vs. Fixed Interest Rate: Your card’s APR can come in different forms. A variable interest rate is usually linked to the prime rate. As that fluctuates, so does your interest rate. A fixed rate is less likely to change. If a company decides to adjust the fixed rate, they must notify you first.