Basic Credit Card Annual Percentage Rate

One of the most basic credit card stuff you need to understand is annual percentage rate. This is not just the nominal interest rate. Interest rates are what you are charged for purchases and cash advances.

However, the annual percentage rate (APR)includes annual fees, late fees, over the limit fees, and any other fees the credit card companies charge. All these charges are just a form of interest, so when you add these fees in as interest the APR increases dramatically. All fees are a cost of borrowing credit. Once you pay any fee, the APR increases accordingly.

Wikipedia:

There are at least three ways of computing effective APR:

* by compounding the interest rate for each year, without considering fees;

* origination fees are added to the balance due, and the total amount is treated as the basis for computing compound interest;

* the origination fees are amortized as a short-term loan. This loan is due in the first payment(s), and the unpaid balance is amortized as a second long-term loan. The extra first payment(s) is dedicated to primarily paying origination fees and interest charges on that portion.

For example, consider a $100 loan which must be repaid after one month, at 5% interest, plus a $10 fee. If the fee is neglected, this loan has a (year-long) effective APR of approximately 79% (1.05^12 =~1.7958). If the $10 fee were considered, the interest increases by 10% ($10/$100) for the month, with the effective APR being approximately 435% (1.15^12 =~5.3502, as 535%-100%=435%). Hence there are at least two possible "effective APRs": 79% and 435%.

More Basic Credit Card Reasons For Card Cancellations and Limit Reductions

It is amazing how fast the credit environment has changed in the last 2 years. Everyone had become more credit savvy and understood the term and conditions of cards, annual percentage rates, FICO scores, debt to income ratios, and most things you could think of. We managed our credit cards and paid them all on time to maintain the best credit profiles as possible.


And yet all this effort seems for nothing. The banks and credit card companies are doing something unprecedented. They are taking preemptive action to eliminate risk regardless of the individual's personal situation. Across the board, they are cutting credit card limits and canceling cards because the recession dictates it. There are many stories of people getting their credit cards canceled or credit limits drastically reduced.

Federal Reserve Study Shows Banks Tightening Credit Card Approvals, Increasing Rates and Fees

The Federal Reserve issued a statement this month that essentially agrees with the findings of private studies and journalists about the state of the credit card industry. Releasing results from its quarterly survey of banks to journalists, the Federal Reserve noted that more banks rely on fees and finance charges from cardholders in good standing to offset losses from defaulted accounts.

Therefore, according to the Fed's survey results, many banks intend to increase annual fees, raise interest rates, and pursue more service charges on most credit card accounts. Some survey respondents told researchers that some of their companies' actions were prompted by pending credit card regulations. However, most bank officials responding to the Fed's request noted that credit card account changes were mostly designed to insulate lenders from the effects of a sour global economy.

Roughly one in four banks responding to the Fed's survey reported tightening their credit card approval standards in the past quarter. While that figure may sound high to casual observers, industry analysts note that a similar survey conducted in the summer of 2008 resulted in a 75% affirmative response to the same question. Lending industry observers note that this trend represents a more prudent approach to offering credit cards and setting credit limits, compared to the loose market of only a few years ago.

HIgher interest rates on the way for everyone

In the past credit card companies would base your interest rates on your personal credit profile, job stability, and net worth (assets minus liabilities). That was the past and under the new economy, they are making decisions across the board on their entire credit card portfolio.

Frankly, the credit card companies are bleeding losses through charge offs that reflect the current unemployment rate of +10%. That is an extremely high number and will continue to go only up in the near future. Thus, the credit card companies have to make up the money through higher interest rates and fees on the remaining credit card customers.

New York Times:

In their defense, banking officials say they have no choice but to raise rates and limit credit. Because of the new rules and the prolonged economic malaise, they say it is now far riskier to issue credit cards than it was just a few years ago.

“We sell credit; we don’t sell sweaters,” said Kenneth J. Clayton, senior vice president for card policy at the American Bankers Association. “The only way to manage your return is through the price of the product or the availability.”

The nation’s largest banks are scrambling to figure out a new business model that fits within the new rules and current economic conditions. Those banks made handsome profits over the last decade by charging high interest rates and penalty fees to a small group of customers who routinely paid late or exceeded their balances.

Already, banks are shifting to a model in which a smaller pool of Americans will be eligible for credit cards, and customers with cards will probably pay more for the privilege through annual fees and higher interest.