Credit cards are convenient but come with strings attached. While credit card offers often flood the mail of many homes, it is important to read the fine print in order to avoid hundreds of dollars of unnecessary costs. Easy credit can be a trap, so it is essential to understand the difference in credit card interest rates.
The first thing to understand is that credit cards are very different from bank loans. Banks offer better interest rates for lump sum loans because the rules are very different. Bank loans have to be examined and approved by the bank, and payments are made on a fixed schedule. If a borrower faces bankruptcy, often the bank is paid before other creditors.
A credit card, by comparison, is often written off by the lender as a bad account whenever someone refuses to pay the balance. While refusing to pay a credit card balance will damage a person’s credit rating, often credit card companies do not pursue small debts because they are not worth collecting. Because credit card companies deal with defaults more often than banks, they carry higher interest rates to reflect their increased risk.
It is also true that credit cards are intended to be short-term loans. The lender makes money available for almost any type of purchase, at any time, and this is a risk to the lender. Aside from the liability of being a short-term lender, credit card providers simply charge a premium for a convenient service. All of the major card providers, such as Visa and Mastercard, started as lenders and created large service networks.
The final reason why the annual percentage rate is high is because many cards come with a grace period of thirty days. If the balance is paid by that time, then the lender receives no interest and this stacks against paid benefits such as points and cashback. Credit cards are very much a game where the lender offers zero interest for a limited time, and the borrower risks having to pay a higher interest if they cannot beat the clock.
People are initially attracted to credit cards because of the attractive incentives, but those incentives are paid by people who cannot afford to repay their loans quickly. Consumers have freedom of choice but must weigh their options carefully. Some credit cards can be great deals if the timeline can be managed.
One option is just to avoid credit cards that come with needless frills. The only sum of money that is likely to be paid back in a 30-day period is the smallest of purchases. Anything bigger amounts to a mid-term loan. Choose a card with a low-interest rate and skip the frills. Some cards come with a low base interest rate and are reasonable for midterm loans.
Another option is to have more than one credit card with different conditions. Some cards offer cash back on gas purchases, while other cards offer discounts on groceries. Also, carefully examine the penalty APR. Find a card where the penalty rate is reversible if good payments are resumed.