Understanding interest rates and repricing
Whether you’re new to getting a credit card (or personal loan) or have been the proud owner of one before, you might have an idea about the interest rate that is applied to any spending you do over the course of a month.
It’s important to grasp how it works, as this will dictate how much you might be charged for spending on it every month. As another wise guru once said: “Whilst knowledge is indeed power, a lack of knowledge leads to high credit card bills and the unsafe operation of heavy machinery”.
Below we’ve put together a short guide on interest rates and repricing, as this can help for those wanting to understand how credit cards or loans work and what they can expect to be paying on top of their spending. If you’re in this position and would like to understand interest rates, or how the lender can change or reprice your rate, read on.
How is my interest rate calculated?
The interest rate is applied to a credit card or loan, and is calculated over the course of a year of using the financial product. Quite simply, if you borrow £1,000 for 12 months at an interest rate of 5% you will be charged £50 for doing so.
However, if you plan on taking the credit card or loan out over a longer period such as 20 years, you’ll find that compound interest will increase the debt substantially. This is because as the debt grows the interest will be charged against the original amount, plus the interest on top.
Taking the first example, after a year of £1,000 at 5% you will owe £1,050. At the end of the second year you will owe interest on the original £1000 as well as interest on the £50 interest that had been accumulated. Over 20 years you would actually end up owing £2,653.30 in total, but without compound interest it would just be £2000.
What does APR mean?
The APR stands for Annual Purchase Rate, and is the standard rate that lenders and card providers use to represent what you will pay on top of your spending. It includes not only the interest rate decided by the lender or card provider, but also any additional fees included, such as an arrangement fee.
This can also be complicated further if you have an interest rate that changes over time. A variable rate APR for a credit card means that the lender can make small adjustments to the rate at their discretion. These changes are rarely anything to worry about though as they are just changing in line with the economy.
Alternatively, you can get fixed-rate interest, but usually with a loan or for a short period as part of a mortgage. This is sometimes easier to manage as you can predict exactly how much your repayments will be.
How else can my interest rate rise?
Your card provider can also choose to change the interest rate themselves. This is often referred to as behaviour-based repricing. For example, it can normally happen due to the following actions by a credit card borrower:
- Missing a payment or multiple payments
- Start paying off less every month
- Open too many credit agreements
- Make too many cash withdrawals
If the card provider chooses to increase your interest rate they must inform you 30 days in advance. This at least gives you some time to consider whether you want to keep the card or pay it off and close the account.
In addition, your interest rate might change because you’ve come to the end of a fixed-rate period or just a period of 0% interest that was included as part of the deal. This is most common on credit cards or mortgages. If you find your interest rates shooting back up, you might want to change credit cards or in the case of your mortgage, think about remortgaging.
Why have I not got the advertised APR?
This is generally due to the fact that you’re seen as a less desirable candidate by the lender, due to a poor financial history or another negative mark against your credit file. However, the lender or card provider are still willing to offer you a similar deal, but just with a higher APR. This is also referred to as risk-based pricing or representative APR.
If you read the summary box attached to your financial product, you will find that it says representative APR. This is an indication that this APR is offered to at least 51% of applicants. If you don’t quite meet the criteria set by the lender or card provider though, they can offer a higher interest rate instead.
Always remember the summary (box)
If you’re unsure about your interest rate or how long your low rate period lasts for, make sure to dig out the summary box document that will have come with your credit card or loan. Read our guide on summary boxes here for more information.
On the other hand, if you’re ready to apply for a credit card or loan, you might benefit from using our moneymatcher comparison tool. Simply enter a few personal details and you will be able to browse through tailored results that you’re eligible for. The best part is that it won’t leave so much as a mark on your credit score.