Credit Card Interest Rate Traps: Multiple APRs, Penalty Rates & Deferred Interest

To avoid expensive mistakes when choosing and using a credit card, be sure to understand the different types of APRs for different situations.

Your credit card interest rate (the APR) may be more complicated than you think. It may change over time, you may have a different interest rate for different types of credit card use, and it might skyrocket if you make a late payment or go over your credit limit. In order to avoid making expensive mistakes when choosing and using a credit card, make sure you understand the different types of APRs and what your company can charge you in different situations.  

(To learn what an APR is, see  Understanding Credit Card APRs.)

Understand Variable Rates

Many cards today charge variable rates that are linked to an index that moves with market forces. So from one year to the next, the cost of not paying off your balance each month may change dramatically, for example, from 13% to 25%, depending on how volatile the index is. Even cards with “fixed” annual percentage rates may only be fixed for a period of time, and then change to a variable rate. A credit card agreement should specify how long the fixed rate applies. If it doesn’t, the fixed rate should apply for as long as you keep the card. At the end of a fixed rate period, the company generally has to give you at least 45 days’ notice before it can change the rate.

Be Aware of Multiple Interest Rates

Many cards have different APRs for balance transfers, purchases, and cash advances. Sometimes there are different introductory APRs on the three types of use, as well. It can become very confusing to figure out what rate you are paying or compare rates when you want to get rid of cards or get a new card.  

As a general rule, look for the lowest and most stable APR that will apply to the way you plan to use the credit card (for example, if you plan to use the card to get cash advances, look at that APR). If you carry a balance from month to month, even a small difference in the APR can make a big difference in how much you’ll pay over a year.

Example: Suppose that you have a credit card with an APR of a whopping 28% and that your balance last month was $1,250. To calculate this month’s finance charge, the credit card issuer multiplies the outstanding balance by one-twelfth of the annual rate (28% รท 12) x $1,250 = $29.16). If you make the minimum payment required, let’s say, $32, then $29.16 pays off this month’s finance charge, so only about $3 goes to reducing your outstanding balance. On the other hand, if your APR was 13%, $13.54 would go to pay off the finance charge for the month and $18.45 would go toward paying off the balance. Exactly how much goes to pay off your balance depends on the method of computation the card issuer uses.

(To learn how balance computation works, see  How Do Credit Card Companies Calculate Your Balance for Billing?)

Watch Out for Introductory “Teaser” Interest Rate Offers

Credit card companies know that consumers compare interest rates (APRs), so they frequently offer very low APRs, often on balance transfers. The very low APR applies for only a few months and is followed by a very high APR afterwards. If you still have a balance outstanding when the low rate ends, the high rate applies to the balance as well as new transactions.

You may lose the low introductory rate even sooner, for example, if your payment is even one day late. Check the company’s disclosures of terms and conditions to see if the APR is an “introductory” rate and, if it is, how long it lasts. If you get a card with a low introductory rate, be sure you can pay it all off before the higher rate kicks in.

Avoid High Penalty Interest Rates

According to the U.S. Government Accountability Office (GAO), beginning in the late 1990s, companies started charging default or penalty rates. Your regular interest rate might be around 14% on a fixed-rate card. But you can easily trigger a “default” rate that is much higher -- 30% is common.

What may trigger a default rate? Usually, going over your credit limit or making one or more late payments. The default rate applies to any new balance, not just to the late payment. You could wind up paying the default rates for months, years, or indefinitely. And if you are more than 60 days late with a payment, the default rate can apply to the outstanding balance as well (but you can get it reduced on the outstanding balance by making the next six payments on time).  

Be Wary of Store Card Deferred Interest Promotions

Stores sometimes offer credit card promotions that promise “no interest if paid in full in [xx] days.” Be wary of these promotions. If you do not pay off the entire balance by the end of that period, the card issuer may charge interest (usually at a high rate) on the entire amount from the day you made the purchase. So, if you buy a stove for $500 and pay only $400 by the end of the zero-interest period, the store can charge you interest on $500 from the day you purchased the stove.

It gets trickier if you already have a balance on the card you use to make the “no-interest” purchase. In that case, any payments on the card will not necessarily go toward the no-interest purchase. The company can apply the minimum required payment as it likes. Anything you pay above the minimum payment amount will be paid on the balance with the highest interest rate, with one exception. The company must apply the two payments that come due right before the end of the zero-interest period to the zero-interest purchase balance.

For example, say you have a $300 balance with a higher interest rate on the card before you buy the stove. The company can apply your minimum payments to either balance, but will apply any additional amounts you pay (except your last two payments) to the higher-interest balance, not to the balance for the stove purchase. That means that you may pay $500 on your card before the end of the zero interest period, but still have an outstanding balance for the stove purchase. You can always ask the creditor to apply all of your payments to the “no-interest” purchase first, but the credit card company does not have to comply with your request.  

(To learn more about what to look for and what to avoid when shopping for a credit card, visit our  How to Choose a Credit Card  topic area.)  

This is an excerpt from  Solve Your Money Troubles, by Margaret Reiter and Robin Leonard (Nolo).

Talk to a Lawyer

Need a lawyer? Start here.

How it Works

  1. Briefly tell us about your case
  2. Provide your contact information
  3. Choose attorneys to contact you
Swipe to view more

Talk to a Consumer Protection attorney.

How It Works

  1. Briefly tell us about your case
  2. Provide your contact information
  3. Choose attorneys to contact you