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When you apply for a credit card, one of the things to check is whether the card comes with variable or fixed interest rate, as this determines how reliable your interest rate will be. To determine the pros and cons of each type of card, let’s take a look at the difference between a variable and fixed rate card.
Fixed Rate Credit Cards
Fixed rate credit cards are just what the term says-credit cards with an interest rate that doesn’t change. The term ‘fixed rate credit card’ used to come with many qualifications, because in the credit card terms, card issuers gave themselves plenty of leeway to change the interest rate “at any time, for any reason.”
After the new credit card laws step into effect in February of 2010, however, fixed rate credit cards will actually have a fixed rate-to a degree. Credit card companies will only be able to change the interest rate on existing balances on the card under certain circumstances. This is good news if you carry credit card debt on a fixed rate credit card, because you’ll have greater certainty about what your interest rate will be. (Card issuers can still increase the interest rate for future purchases, however, they just have to give you 45 days notice.)
Of course, credit card companies are experts at stacking terms in their favor, so it comes as no surprise that in preparation for the new credit card provisions, many cardholders have seen their fixed rate credit card changed to a variable rate card. Some industry observers even predict that going forward, credit card companies will only offer credit cards with a variable rate.
Variable Rate Credit Cards
In the U.S., the APR of variable rate credit cards is based on the prime rate (the index) plus a fixed rate (the margin). This means that the interest fluctuates along with the prime rate. The prime rate is the interest rate banks pay to borrow money from the Fed. The prime rate is based on the federal funds rate, set by the Federal Reserve, and it is 3 percentage points above the federal funds rate.
The prime rate fluctuates as the Federal Reserve raises or lowers the federal funds rate. As a consequence, the APR on variable credit cards goes up and down in step with the rise and fall of the prime rate.
While card issuers in the past have been able to jack up the interest rate on variable rate credit cards by increasing the margin rate (from e.g. 6.99 percent to 14.99 percent), this won’t be the case anymore once the new credit card law steps into effect. This means that the APR on variable rate interest cards will only increase when the prime rate increases.
So if you have a variable rate credit card, do you need to worry about interest rate increases? Well, yes and no. The prime rate has remained stable for a long time, fluctuating little more than one to two percentages over several years. Chances are that you won’t see any dramatic fluctuations in your credit card APR with a variable rate credit card, at least over the short term.
At the same time, however, the prime rate is at historic lows: at 3.25 percent as of September 1, 2009. Once interest rates begin to rise again, cardholders with variable rate cards could find themselves squeezed by steadily climbing APRs. The prime rate peaked at 20+% in the inflationary environment of the 1980s, levels to which it is not likely to return to anytime soon. However, not more than two years ago, in September 2007, the prime rate stood at 8.25%. For cardholders with a variable rate credit card, such fluctuations in the prime could translate into considerable increases in their credit card APR.
If you carry credit card debt on a variable rate credit card, which is the best way to protect yourself? The logical step might be to apply for a fixed rate credit card, however, these are becoming increasingly difficult to come by. According to a survey by Consumer Action, only five out of 39 credit cards in 2009 had a fixed rate, down from 13 out of 39 just a year earlier. A better alternative would be to look for a variable rate credit card with a low margin, or even better, take steps to gradually pay off your credit card debt.
