How Does Interest On Credit Cards Work


Interest Rate And Apr: Are They The Same Thing

How Credit Card Interest Works (Credit Cards Part 2/3)

Interest is the price that you pay for the use of somebody elses money. You can think of a loan as renting money, and the interest as the rental cost. Interest is usually a percentage of the sum that is borrowed, but it can be computed in many different ways.

When credit card companies discuss interest rates, they usually refer to an APR, or annual percentage rate. The APR describes the cost of borrowing on an annual basis. The APR allows you to compare the interest costs of different cards directly.

Its easy to get confused by the difference between the APR of an installment loan and the APR of a credit card. The APR of an installment loan, like a personal loan or a car loan, includes interest, fees, and any other loan costs. It indicates the total cost of the loan.

Credit cards and other forms of revolving credit use the term APR differently. The APR of a credit card is essentially the same as the interest rate and does not include fees or other costs. In fact, the Truth in Lending act requires credit card companies to express their interest rates as APR. When a credit card company describes your interest rate, they will almost always refer to it as the APR. This figure does not include fees and you should assess those separately.

Pay Off Your Balance As Soon As Possible

While paying the minimum credit card payments on time will help you avoid interest, its still playing with fire. It only takes one emergency to keep you from paying your bill in full. Before you know it, you could be buried in a pile of interest. Instead, the smartest way to avoid credit card interest is to pay off your balance as soon as possible. That means getting aggressive!

Personal finance is 80% behavior and 20% head knowledge. And the debt snowball method is the fastest way to tackle your credit card payments because it helps you change your behavior.

Heres how it works:

Step 1: List your debts smallest to largest, regardless of interest rate . Pay minimum payments on everything but the smallest balance.

Step 2: Attack the smallest debt with everything youve got. Once that debt is gone, take that payment and apply it to the second-smallest debt while continuing to make minimum payments on the rest.

Step 3: Once that debt is gone, take its payment, and apply it to the next-smallest debt. The more you pay off, the more your freed-up money grows and gets thrown onto the next debtlike a snowball rolling downhill.

The debt snowball method works because it helps you gain momentum as you go and keeps you motivated as you crush those debts one at a time!

And listen up: The faster you work on your debt snowball, the sooner those credit card paymentsand that interestwill stop cramping your monthly budget.

How Do Credit Card Interest Rates Work

Credit cards charge interest on your balance if you dont pay it off before the end of a billing cycle. Interest is an amount that you owe thats added onto the amount you borrowedits basically the cost of using the credit card . If you have a balance on your card for multiple billing cycles, youll owe interest on the money youve borrowed. And credit card interest tends to be pretty high, which means that debt can begin to accrue quickly if you dont pay off your balance completely. According to the Federal Reserve, the average credit card interest rate in Q3 of 2021 was 17.13%you can see why its usually best to avoid paying interest.

Heres an example of how interest works. Lets say youve put $500 on your credit card. Many cards have a minimum payment optionrather than paying the full $500, for example, you could just pay $40 and not be charged a late fee. If you pay that $40, however, the remaining $460 will still be on your balance accruing interest. If your interest rate is 20%, your new balance will be $552, including the new $92 in interest.

Another common term youll see when shopping for a credit card is APR, or annual percentage rate. This refers to your cards interest rate. For some financial products, APR is different from the interest rate, but this is not the case with credit cards.

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What Determines A Credit Cards Interest Rate

As the CFPB explains, âThe credit card company may decide which interest rate to charge you based on your application and your credit history.â Generally, the higher your credit score, the lower your interest rate might be.

The interest rate, or APR, can either be variable or non-variable. A variable APR is often based on the prime rateâan index that most lenders use to set their own interest rates. And a variable APR could change when the prime rate changes. A non-variable APR typically stays the same, but it can change under certain circumstances. For example, your non-variable APR could increase if you make late credit card payments or miss payments, depending on your card issuerâs policy and your card terms.

A credit card may offer an introductory or promotional APR on purchases and balance transfers. After the introductory or promotional period ends, the rate will return to the standard APR disclosed in the cardâs terms.

Is There A Grace Period For Card Payments

Credit card interest free period  how does it work?

Most credit card companies allow a grace period of at least 21 days, sometimes even 30 or longer, to pay off your account balance. The grace period starts the day your monthly statement closes, which is different from your cards payment due dateusually later in the month. If you bank online you likely receive your statements as soon as theyre issued. If you receive paper statements, it may take a few days.

Read Also: What Is The Interest Rate On Personal Loans

How To Avoid Paying Credit Card Interest

Of course, none of these interest rate calculations are relevant if your card issuer waives the interest charges. Nearly all card issuers won’t impose interest charges when the entire statement balance is paid in full on or before the due date. The period of time between the statement closing date and the due date is called a grace period.

Technically, interest charges apply during this period, but they are waived if the entire balance is paid in full and on time. By law, credit cards that offer a grace period must give you at least 21 days to avoid interest by paying your balance in full. For more information, see “What Is a Good APR for a Credit Card?”

What Is A Credit Card Interest Rate What Does Apr Mean

A credit cards interest rate is the price you pay for borrowing money.

For credit cards, the interest rates are typically stated as a yearly rate. This is called the annual percentage rate . On most cards, you can avoid paying interest on purchases if you pay your balance in full each month by the due date.

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How Can I Avoid Or Pay Down Interest Charges

You can usually prevent interest charges altogether on your credit card. The simplest way to never pay interest and maintain your monthly grace period between statements and payment due dates is to simply align your payments with all due dates, statement periods and policies associated with your credit card. Never carry any balance and youll avoid interest altogether.

Different Types Of Interest And Apr

How Credit Card Interest Works: The Math

There are other details in your cards fine print you should review to understand how much you could pay in fees if youre not careful. Heres what you need to know.

A credit card can either have a fixed APR or a variable APR. A fixed APR typically remains the same, but it can change in certain circumstances, such as if your payment is more than 60 days late or when an introductory offer expires. A variable APR usually changes with the prime rate. Many variable interest rates start with the prime rate, then add a margin. The result is your variable APR.

The purchase APR will be used to calculate how much interest you will pay on an outstanding purchase balance, if you have one. If you have excellent credit , you may be more likely to qualify for a lower interest rate because a credit card company may consider you a lower-risk customer.

If you have poor or fair credit , you may get a higher interest rate if you are approved for the card. This means itll cost you more every time you carry a balance with your card, so be sure to pay off your balance on time and in full every month, if possible.

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How Much Is Credit Card Interest & How Is Credit Card Interest Calculated

To find out how much interest youre paying on your balance each day, you can convert your APR to a daily percentage rate. To do so, divide your APR by 365, the number of days in a year. At the end of each day, the card issuer will multiply your current balance by the daily rate to come up with the daily interest charge. That charge is then added to your balance the next day, a process called compounding.

For example:

If your credit card has an APR of 15%, it will have a daily rate of 0.041096%. Lets say a cardholder has a balance of $1,000 at the 15% APR standard interest rate. The next day, interest is added and the balance becomes $1,000.41, plus any additional purchases and minus any new credits or payments. This process occurs each day until the end of the cardholders monthly statement cycle. So at the end of the month, the beginning $1,000 balance becomes $1,013 when interest charges are applied at 15% APR.

How Interest Charges Are Applied To Your Credit Card

Interest is the money youll pay if you dont pay your credit card balance in full by the due date. Youll continue to pay interest until you pay your balance back in full.

Interest rates vary depending on your financial institution and the type of transaction. For example, you may pay 19% interest on regular purchases and 22% on cash advances or cash-like transactions. Rates for specialized and retail credit cards may be higher.

Your credit card statement and your credit card agreement must clearly indicate the interest rates you must pay.

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What Is A Good Apr For A Credit Card

A good credit card APR is below the average APR. Keep in mind that only people with excellent credit qualify for below-average APRs.

An above-average APR isnt necessarily a bad thing. But the higher an APR is, the more youll pay for purchases, cash advances and other credit card transactions unless you pay off your balance in full every month, thus avoiding interest charges altogether.

What Are The Different Types Of Apr

How Do Credit Card Apr Rates Work / Beginner

The APR most people are familiar with is the purchase APR. There are several types of APR, however, that you should be aware of.

  • Purchase APR: This is the interest rate applied to all purchases made with your card online, in person or over the phone.
  • Introductory APR: A promotional interest rate for a limited period of time that is lower than the cards regular APR, sometimes as low as 0 percent APR. It can apply to purchases or balance transfers or both. Once the introductory period expires, the regular APR will apply to your balance.
  • Cash advance APR: The rate for borrowing cash from your credit card is typically higher than your purchase APR and doesnt have a grace period. Its also often applied to convenience checks.
  • Penalty APR: This applies to missed or returned payments and could go as high as 29.99 percent. You might have to make several consecutive on-time payments before your credit card issuer removes the penalty APR. Payments more than 60 days past due could result in the penalty APR applying to your current balance, as well.

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Minimum Credit Card Payments Can Get Out Of Control

Always aim to repay as much as you can. If you only make the minimum payment, itll take a long time to pay off your debt and youll end up paying a lot more than you borrowed.

For example, if you had a £1,000 balance, are charged 22% interest and no longer use the card:

Monthly repayment

12 months

If you feel youre not able to manage your repayments or youve been contacted by your card provider, help is available.

Lenders are required to suggest higher affordable repayments. If you do not respond, or ignore the issue, and the situation persists for more than 36 months this could lead to your account being suspended.

Whats A Credit Card Grace Period

When you use your credit card to make a purchase, you have a grace period in which to pay it back. During this time, no interest is charged. If you pay your balance in full, it is only the amount you borrowed for your purchase. Grace periods may vary by credit card issuer, but it is usually less than 30 days, often 20 or 25 days.

If you want to avoid paying credit card interest, be sure to pay attention to your grace periods. Generally, if you pay the balance on your credit card bill by the due date listed on the statement, you wont have to pay interest. You dont want to assume thats true of every purchase, however, so double-check your cards terms and conditions.

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Types Of Credit Cards

There are several types of credit cards, with the biggest category being rewards cards. Rewards credit cards can include travel-related rewards earned for purchases. As well, you may earn more rewards for spending in certain categories. Many reward cards are co-branded with certain airlines or hotels.

Similar to rewards cards are cash back card, which offer a certain level of cash back for spending. Secured credit cards are for those looking to build or rebuild their credit. If your credit profile is thin, you may be able to get a secured card, which requires a security deposit that is held as collateral by the issuer.

Student-focused credit cards also help those with little credit history build credit. These cards are tailored to those in college and may offer little in terms of rewards.

Whats The Average Credit Card Interest Rate

How do credit cards and credit card interest work?

You may be surprised to find that APRs on credit cards can inch all the way up to 26.13%.2 Thats more than a fourth of your balance! Depending on how much you carry on your account, that could add up to . . . well, a lot. Even just $100 left unpaid each month could result in an extra $25 you owe by the end of the yearand lets be real, people carry way more than just a Benjamin Franklin on their credit card statements.

As of 2019, the average APR on credit card accounts is around 16.88%, which is almost 4% more than it was five years ago.3 And thats after the Federal Reserve slashed interest rates for the first time in over a decade!4

Of course, different lenders handle interest rates many different ways. And depending on the kind of card, your interest rate may be higher or lower than the average APR nationwide. But with the average American household knee-deep in $7,136 of credit card debt, you better believe APRs will continue to rise.567

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Foreign Currency Conversion Charges

Financial institutions calculate foreign currency charges in different ways. Some transactions are converted directly into Canadian dollars. Others may be first converted to U.S. dollars and then to Canadian dollars. The foreign currency conversion charge is applied after the purchase is converted to Canadian dollars.

Example: Foreign currency conversion charge calculation

Suppose you made a 1,000 purchase with your credit card. The exchange rate is 1.42 to convert euros directly to Canadian dollars. Your credit card agreement shows a conversion charge of 2.5%.

After your financial institution converts your 1,000 purchase to Canadian dollars, it will cost $1,420. The 2.5% foreign currency conversion charge is applied to the $1,420 for a fee of $35.50. The total amount of your purchase is $1,455.50 in Canadian dollars.

Read the terms of your credit card agreement for the total foreign currency conversion charge. Ask your financial institution about anything you dont understand.

Qualifying For The Best Rates

To qualify for the best rate, youll need to have good credit. Most credit cards that accept bad credit carry high interest rates. While you may want to apply for them to help improve your credit score, just know you wont get the best rates.

Once your credit score improves, you can apply for a new credit card with a better rate. The key is to show you are responsible with credit by making all your payments on time and paying down the balance as quickly as you can.

Youll also find that many credit cards which offer rewards carry a higher rate and an annual fee. This happens because of the cost of the rewards. If the rewards are valuable enough, or you dont usually carry a balance, it may not matter about the interest rate, but its still important to be aware.

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