People usually see cards with rates that quickly change as variable rate credit cards, while those that “do not change” are fixed rate credit cards. But how can you really tell these two apart?



We must first understand the nature of rising and falling borrowing rates. The Federal Government Reserve Board increases or decreases the discount rate based on certain pointers in the economy.

This discount rate refers to the rate that the Fed Reserve charges a bank whenever it borrows money from the Fed Reserve when it is temporarily short of funds. As expected, especially when the Fed Reserve increases its discount rate, the banks pass this increase to its customers. In the case of credit cards, banks raise the prime rate, the most favorable interest rate charged on short term loans.

The Variable Rate plan uses indexes such as the prime rate or Federal Reserve discount rate. Once the interest rate equivalent to the index has been identified, the issuer will add points, or a margin, to the index to determine the rate that will be charged to the customer. When the index, e.g. the prime rate, changes, the interest rate of a variable rate credit card correspondingly changes. If the prime rate increases by 1%, the interest rate also increases by 1%.

The Variable Rate plan is usually customer friendly when the prime rate falls. However, banks keep a “floor rate”, or a minimum interest rate, to maximize their profits whenever the prime rates fall. If the prime rate is below the floor rate, the interest rate of the credit card will be based on the floor rate.

If the prime rate increases above the floor rate, it will be the basis of the card's interest rate. When the prime rate or index increases, this allows the bank to fully pass this increase to the customer.

On the other hand, the rates for Fixed Rate Plans are not directly affected by the changes in the index or prime rate. If the prime rate increases or decreases, the fixed rate usually stays the same. If the fixed rate changes, it is only a fraction of the actual change in the index.

If fixed rates will be raised, the Truth In Lending Act provides that a 15–day notice should be released before actually increasing the rate. Some states have laws that require more than a 15–day notice.

Take not that there isn't any real “fixed rate” credit card. Why? Because whether we like it or not, banks have to modify their interest rates according to the prevailing index rate. Even though a card has a fixed rate, it will still change on certain occasions, unlike the variable rate card, which regularly changes its rates. And fixed rates may also increase periodically, say annually. If the index rate becomes very volatile, fixed rate credit cards are inevitably changed to variable rate cards.

To determine whether a variable rate card or fixed rate credit card is suited for you, start by reading the Rate Reports that are released by expert financial analysts. These reports will give you a good picture, if not a thorough understanding, of the current lending rates. Then, carefully examine the details and terms of the bank's credit card plans.

Take note of the maximum and minimum rates that the bank may charge you. If you find that the minimum variable rate of the bank is higher than market interest rate due to a falling trend, you may want to find another bank or lender.