Why are credit card APRs so high?

After the Federal Reserve raised the federal funds rate three-quarters of a percentage point for the fourth time in November, everything affected by that rate is sure to get steeper as inflation rages on throughout the country. As such, credit card rates continue to rise and show no signs of slowing down.

Unlike your home or auto loan, credit cards are basically unsecured loans, “so there’s no collateral,” said Miriam Mitchell, chief lending officer at Addition Financial, in a previous interview.

Credit cards are “heavily risk-based,” she says. Default rates for credit card rates are also higher than for other types of loans, Mitchell said.

Despite the much higher rates for credit cards, you can reduce or avoid paying this particular interest. The trick is to take steps to reduce — or eliminate — what you owe on your credit cards.

How are credit card interest rates set?

Credit card interest rates are tied to the prime rate, which is based on the federal funds rate set by the Federal Reserve. The federal funds rate is currently 4 percent, while the prime rate is 7 percent. Though issuers are not required to change their APRs on new cards when federal interest rates go up, most do.

As such, the average credit card interest rate is 19.20 percent, at the time of writing. That is the highest national average APR on record, and it’s only expected to increase.

Why does credit card APR vary?

Most credit cards have variable APR, which is subject to change under a variety of circumstances. A major one is when the prime rate changes, as we discussed above. Other situations include when your payment is late, your intro APR period ends and your credit card issuer changes it.

When shopping for a credit card, you’ll often see that the APR is presented as a range, for example between 16.99 percent and 27.99 percent. Your assigned APR depends on your creditworthiness, which is also determined by your credit history, debt-to-income ratio and more. If you tend to pay your bills on time and in full, you’ll likely get an APR on the lower end of the range. Of course, those who practice bad credit habits will be assigned a higher APR.

When it comes down to it, however, credit card APRs vary because it’s one of the primary ways credit card issuers make money. Lenders are betting on you not making consistent, full payments so they can charge you interest, which is why it’s so important for them to assign an APR that corresponds with your creditworthiness.

With credit cards, “the lender is compensated for taking on risk,” said Jason Vissers, a writer at MerchantMaverick.com, in a previous interview.

How is your credit card APR calculated?

Your credit card interest rate is calculated as a percentage of the account balance and then is annualized to determine the annual percentage rate. If you’d like to know the APR applied to your current credit card balance, simply multiply your daily rate with your average daily balance and number of days in a billing cycle.

The APR on your card is also influenced by your credit score and the type of card you hold. At the time of writing, the CreditCards.com rates survey found the average rate for a low-rate card was 16.28 percent, while the average for a rewards card was 18.99 percent.

Higher rates “help pay for more lucrative benefits of cards,” such as rewards programs, Vissers says.

Your credit score also plays a major role. Mitchell says consumers with credit scores of 740 and above tend to be offered the best rates on their credit cards. Your credit score takes into account such things as your payment history, debt level and length of your credit history.

“Consumers with little to no credit history will pay much more than someone who is well-established, with a history of making their debt payments on time every month,” Melinda Opperman, chief external affairs officer at Credit.org, said in a previous interview.

The card issuer you choose can also impact your APR, Mitchell says, as credit unions often charge lower rates than big banks.

If you pay off your credit card bill each month, the APR your card charges may not matter that much to you. The perks that come with your credit card, such as rewards or insurance benefits, might be more important to you than the APR. But if you carry a balance, interest charges can quickly mount up — and reduce the value of those other perks.

How to reduce the APR on your credit cards

There are numerous ways you can reduce your credit card rates:

Call your credit card issuer

Perhaps the easiest and most straightforward way to lower your APR would be to call up your issuer. Be sure to tell the customer service representative that you have a history of on-time payments and a strong credit score. You may also be able to qualify for a 0 percent APR on a credit card for a limited time if you have good or excellent credit.

If you have good credit and have a solid history of responsible credit use with your credit card issuer, they may lower your interest rate just to keep your business. If your customer representative denies you right away, you could also try to find a better offer from another issuer and relay that information to the representative.

Improve your credit score

If your credit score has improved since you opened that credit card, Opperman says, the issuer might be even more willing to reduce your rate.

The best way to increase your credit score is to make your payments on time each month, she says. Also, double-check your credit report for any outdated or inaccurate information.

“Anything you do to improve your credit should help you pay lower rates in the future,” Opperman says.

Try a balance transfer

Another option might be to transfer your balances to a card with a 0 percent intro APR for a limited time, such as 12 or 18 months, Vissers says. But you have to be vigilant and pay off your balance before the 0 percent APR period expires, or you’ll begin to pay high rates again.

Balance transfers also typically require you to pay a transfer fee, which is generally 3 to 5 percent of the amount you are transferring.

However, a balance transfer can backfire if you shift your existing balances to a new card and continue to use your old one, says Opperman.

“We see a lot of people seeking credit counseling who [have] doubled their debt because they transferred a balance and kept borrowing with the original card,” she says.

Find a better credit card

When looking for a new credit card, Mitchell says, you should understand its purpose and how you’ll use it.

Make use of tools such as CardMatch to measure your creditworthiness for certain cards and compare options from various financial institutions, including APRs, benefits and terms. “One institution could be very different from another,” she says.

“Shopping for the right credit card is going to be key,” Mitchell says.

Bottom line

Although credit card APRs are higher because of the risk they represent for lenders, you can lower yours by improving your credit score or transferring your balance to a card with a 0 percent intro APR. Plus, you can avoid interest charges by paying off your balance each month.