If you were perfect rather than made a mistake, you'd probably pay your credit card balance in full every month. But since the majority of us are mere mortals, we carry debt on our credit cards every so often, and sometimes for quite a long time.
When you don't pay your credit card bill entirely every month, your unpaid balance accrues interest. There is however a lot more to know about charge card interest than that.
Have we piqued your interest? Stay tuned once we explain in depth how credit card interest works and how you are able to pay less of it in the future.
What Is Charge card Interest?
The Consumer Financial Protection Bureau (CFPB) describes a credit card's apr (APR) as \”the price for borrowing money.\”[1] But it is a bit more involved than that.
Credit cards really are a kind of loan. Whenever you make purchases with a credit card, you're borrowing money from the lender (the card issuer) to make those purchases. The lender pays the merchant upfront and also you pay the lender when the cash is due.
If you pay the lender back the amount you've borrowed on time as well as in full, there aren't any interest fees. In effect, you're borrowing money for free.
But if you do not spend the money for entire balance through the payment due date, the balance (what you owe) you're continuing your card will accrue interest, which in turn gets put into the existing balance.
So, the amount of interest will you pay? That amount is expressed like a number of the total amount known as the APR. This number is important to understand – the higher it's, the greater interest your balance will accrue.
What Is Annual Percentage Rate (APR)?
So, what's the difference between the interest rate and the APR? For credit card purchases, the annual percentage rate and the interest rate are identical: the yearly interest rate you'll pay in your card's balance.
For other credit card transactions like balance transfer promotions or payday loans, the eye rate and also the APR are a quite different (we'll explain much more about this in a bit), since the APR also includes fees.
This goes for other lending options too. With a mortgage, for example, the annual percentage rate is the rate of interest plus any fees linked to the loan. So, the eye rate could be 4%, but the APR might be 4.25%.
Where do I find my credit card's APR?
You can find your credit card's APR on your monthly credit card statement as well as in your cardmember agreement. It's usually within a summary table referred to as \”Schumer Box,\” perhaps under a heading called \”interest charge calculation\” or similar.
You may also usually find it fairly easily in your card's app or website. If all else fails, you are able to call the number around the back of your card and get a customer service representative what your APR is.
What's a good credit card APR?
The Federal Reserve Board tracks and publishes average charge card APR monthly. Any APR under the average can be viewed as \”good.\” So, when the average credit card APR is 16.4%, an APR of 15% is nice. Anything lower is much better yet.
But remember that simply because the APR is substandard, it isn't necessarily \”good\” for you personally. A 15% APR can continue to add up to a lot of money, especially when you factor in compounding. An APR that's healthy for you depends upon several factors, just like your personal finances and whether you routinely carry credit debt.
Different types of APRs on credit cards
Earlier, we talked about the way the interest rate and APR for charge card purchases are typically exactly the same number. However, a credit card has different types of interest rates for other functions and transactions, for example cash advances and balance transfer promotions.
Add to that, a card provider can offer lower rates throughout a promotional period when you first get approval. This could be called an introductory APR.
Here are the most typical kinds of credit card APR:
- Purchase APR: The interest charged around the money you spend making use of your credit card
- Balance transfer APR: The rate charged on balances transferred using their company charge cards or other loans. It is typically higher than the acquisition APR, ranging between 8% – 25%
- Cash advance APR: The rate charged if you use your credit card to obtain a cash advance, typically in an ATM. It is also generally greater than the purchase APR, around 25%
- Promotional APR: A special APR for a limited time, usually offered by issuers of credit cards to entice individuals to sign up for the credit card. Sometimes, the introductory APR is really as little as 0%. However, many lenders, like lending institutions, offer a low interest rate cards with fixed rates
- Penalty APR: A higher-than-usual APR the credit company could apply if you don't pay your charge card bill on time. The penalty APR hovers around 29.99%
How Do Credit Card Issuers Determine Your Interest Rate?
Credit cards will often have variable APRs that follow the best rate. \”Variable\” means the APR can change periodically, sometimes monthly. Why?
Credit card providers use the prime rate to determine a range of APRs for his or her cardholders. The best rates are the credit card company's lowest rate, that is usually based on the federal funds rate.
The Federal Open Market Committee (FOMC) sets the federal funds rate. So, when the FOMC raises the federal funds rate, the best rate and your credit card's APR will probably increase as well.
The APR you get will depend not only around the prime rate but additionally in your creditworthiness, which issuers determine by a \”hard pull\” of the credit rating as well as your credit report. They also use this information to find out your credit limit. In general, the greater your creditworthiness, the lower your APR will be for credit cards.
How you payout your loan will often influence your APR. So, for those who have a great APR, but you miss several payments (or do not pay them entirely) and carry credit debt, your charge card company may raise your purchase APR.
How Is Credit Card Interest Calculated?
Calculating credit card interest could be a little complicated, but we'll explain it here in simple, approximate terms:
- Figure out your daily rate of interest: To start, divide your APR (the annual interest rate) by 365, (the amount of days each year).
Let's say your APR is 16%.
.16 / 365 = .00043 (.043%). To simplify, we'll say your daily interest rates are .0004 (.04%).
- Calculate the dollar amount of interest charged daily: Now, let's say you carry a balance of $3,000. Multiply that balance through the daily rate of interest.
$3,000 x .0004 = $1.20.
- Figure the current month's interest charge: Now, we need to understand how long your billing cycle is. Let's imagine it is Thirty days. Multiply your everyday interest amount by the number of days in the billing cycle.
$1.20 x 30 = $36.00. ← Here's your monthly interest charge with that $3,000 balance.
But hold on! That's your interest charge for that first month only. Next, if you don't pay it, your balance increases by that interest amount plus any late payment charges.
So, now let's figure out your interest and balance for the following month.
Let's say you do not buy anything else later. Your balance was $3,000, however it's $3,000 plus the interest of $36.00 plus a $40.00 overtime fee.
- Add your asics: Add your existing balance to the final month's interest and any fees.
$3,000 + $36.00 + $40.00 = $3,076. ← Here's your asics.
- Calculate the new dollar amount of interest charged daily: To calculate the daily interest you'll owe later with the same APR, multiply balance (which is $3,076) by the daily rate (that is .0004).
$3,076 x .004 = $1.26.
- Figure the interest for the billing cycle (30 days):
$1.26 x 30 days = $37.80. ← Here's your new interest charge for that month's billing cycle. - Calculate your new balance: Now, using the interest of $37.80 put into another $40.00 late payment fee, you'll owe an additional $77.80 on your existing balance of $3,076.
$3,076 + $77.80 = $3153.80. ← That's just how much your debt after two months of failing to pay your bill. And also you haven't even made any additional purchases! See how fast it accumulates?
Bottom line: want credit cards wisely and spend the money for bill every month.
How Can I Avoid or Lower My Credit Card Interest Charges?
Yes, you can accrue a great deal in charge card interest and costs very quickly. And the longer you are taking to repay your credit card balance, the greater you'll get charged. Plus, late payments can have a detrimental effect on your credit rating.
We've listed the best methods to avoid paying extra interest and costs and also to protect your credit:
- Pay balance entirely every billing cycle: The most foolproof method to avoid interest along with other fees would be to pay all your credit cards entirely before the payment deadline each month. Should you are usually forgetful, you can set calendar alerts and establish automatic payments. You should also avoid purchasing with your credit cards as much as possible.
- Pay your bill early: Credit cards are revolving credit. So, whenever you pay your bill, you'll reset the quantity of available credit. But perhaps more importantly, if you have a balance and pay it before it's due, you will not accrue additional times of interest.
- Pick credit cards with a low APR: Getting a card with a low APR will help you keep the interest fees down. But browse the fine print. Beware of excessive overtime fees or a hefty annual fee that may offset the benefit of having a low-interest card.
- Transfer your balances to a card having a low introductory APR: Should you already have a balance on a high interest charge card, consider transferring your balance to a card with a low introductory (promotional) APR. But reduce your balance as much as possible during the promotional period to prevent the approaching rate hike. When the promotional APR ends (usually after 6 – 1 . 5 years) the issuer will raise the APR to close your previous rate or even higher. Note that balance transfer promotions can also carry a balance transfer fee.
Any Curiosity about Saving Money?
As essential as it's to understand your credit card's APR and just how interest gets charged, it's also important to consider how using credit cards figures into your financial situation. Guidelines are to pay off your balance in full as well as on time each month, and to look for a card using the best APR and other terms, just in case you need to have a balance for any short while.
