# How Interest Rates Affect Your Debt

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## How Do Interest Rates Work?

The annual percentage rate (APR), also known as the interest rate, is the amount of interest you are charged on the credit card purchases you make. Credit card companies set the APR.

However, banks use the average prime rate to determine how much interest they will charge on loans. The Wall Street Journal calculates the average prime rate for banks and credit card companies rather than a bank or credit card company.

### What Is the Significance of Interest Rates?

If the interest rate is higher, you may pay more in interest payments over the loan’s term.
You borrow \$15,000 at a fixed interest rate of 5 percent for 48 months on a vehicle loan. Over the life of the loan, you’ll pay a total of \$1,581 in interest. If you borrow the same amount for the same period with a fixed rate of 6 percent, you will pay \$1,909 in interest or \$328 more. If you borrow the same amount at 7 percent fixed interest for the same time, you’ll pay \$2,241 in interest — or \$660 more than at 5 percent. This does not include any fees associated with the loan.

For instance, you borrow \$200,000 for a mortgage at 3 percent fixed interest for 15 years. Over the life of the loan, you’ll pay \$248,609.39. If your mortgage rate is 5 percent, you’ll pay \$284,685.71. That is a difference of more than \$36,000.

Now, let’s talk about credit cards. If you have a \$3,000 balance at 15 percent interest and pay it off in two years with \$145.46 monthly payments, you will pay \$491.04 in interest.

Furthermore, if you don’t pay your credit card balance in full each month, interest will accrue on top of the amount you charged to the card, increasing your debt. That may affect your debt-to-credit utilization ratio – the amount of available credit you use compared to the total amount you have. This, in turn, may negatively affect your credit score.

### Different Interest Rates Available on Credit Cards

There are several different types of interest rates to consider when choosing a credit card:

• Fixed APR: this simply means that the interest rate on your credit card will remain constant until the credit card company decides to change it. Even if the sales pitch says “fixed for life,” the company can change the APR at any time.
• Variable APR: the interest rate, in this case, is connected to the prime rate or some other kind of index. Your interest rate will fluctuate as the index does, so it rises and falls with the index.
• Teaser or Introductory APR: this is usually an interest rate the credit card company offers as a promotion for customers to apply for that particular credit card. The interest rate is usually very low, but be aware that it usually only lasts for a limited time (defined by the company in the offer), after which another APR applies.

### What Can Cause My Interest Rate to Increase?

The primary reason your lender can hand you a penalty rate, that is an increase in your interest rate on your credit card, is because you have proven to be a risky investment for the lender (i.e., they are less sure you will pay back all the money you owe). Several factors can make you look like a risky investment.

Late or no payments will most likely result in the credit card company increasing your APR. You will probably have to pay more in the future if you do not pay the first time. Remember that making payments does not just apply to your credit cards.

Lenders will probably raise your interest rate if you prove to be a risky investment. However, they are not legally required to have a reason for raising your APR.

### Interest Rate Example

At 10% APR, the finance charge on a \$20,000 balance would be \$167 per month. A payment of \$400 reduces your balance by about \$233; the rest is interest.

If the same balance had an APR of 20%, the finance charge would be \$333. You would only pay down your balance by \$66 with the same \$400 payment. As your balance is only declining a little bit every month, it will take much longer to pay off your debt.

Using the first example of \$20K at 10% APR, it would take you just over five and a half years to pay off the debt if you consistently made \$400 monthly payments.

With 20% APR, you would have to pay off the balance in just over nine years.

If you want to save money on interest, you need to increase your monthly payment to \$820 per month or get your credit card company to lower your interest rate.

The upside of the higher payment is that you could pay off the balance in 32 months even with the higher interest rate. Even if you don’t think your interest rate will increase, it’s worth trying. If your credit card issuer rejects your application this time, try again in about six months.

### How Much Interest Do You Ultimately Pay

Once you pay off the balance in the first example, you’ll pay \$5,980 in interest. Using the second example, you would pay \$23,360 at a 20% interest rate.

Getting your credit card issuers to reduce your interest rate isn’t always easy, especially if you don’t have the credit history to qualify for a lower rate elsewhere.

If your interest rate increased because you were 60 days late on a credit card payment, the credit card issuer must lower it after six consecutive timely payments.

### Could A Debt Relief Program Lower My Payments and Balances?

Your monthly payment goes to interest instead of your balance when you are stuck in a cycle of paying off large balances with high APRs. It can take years to pay off a high-interest credit card.

It may help to hire a debt relief company if your balances overwhelm you. Credit counseling services are one example. They have trained staff who can walk you through how to pay off your credit cards and improve your credit score.

Interest rates heavily influence consumer debt. The higher the APR on a credit card or loan, the higher your balance will be and the longer it will take to pay it off. If you want to pay off your loans faster, you can reduce your APR or increase your monthly payment.

If you can’t qualify for a lower APR or don’t have the money to make a bigger monthly payment, debt relief companies such as a credit counseling agency may be able to help you catch up on your debts and come up with a payoff plan.

### Should I Seek Legal Help?

Your lender must give you at least 15 days’ notice when they change your interest rate. If your lender does not do this, or you feel they might have violated some other aspect of fair business practice, you may want to consult a credit lawyer specializing in consumer credit. In a lawsuit against your creditor, your attorney can advise you of your rights and let you know if you might be entitled to compensation.

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