Understanding Credit

Key takeaways

  • Find out if your credit card has a grace period each month during which it does not charge interest.
  • Interest rates for the same credit card can vary from person to person.
  • Credit card companies use the average daily balance to determine how much interest you owe each month.

Credit cards are a convenient way to pay for things. We can swipe a card and pay for dinner, clothing, fuel, etc. We know we’ll get a monthly bill, or “statement,” and, ideally, we pay off the balance—or at least the minimum payment—by the due date. If we can’t pay off the entire statement balance, no problem. The credit card company will roll over the rest.

It sounds simple, but that revolving balance comes with a cost: interest. And without understanding credit card interest charges or how that interest accumulates, you could get yourself into more credit card debt than you can handle. It might leave you scratching your head and wondering: How does credit card interest work?

So, let’s take a closer look at how credit card interest works, what it is, and how it can impact your personal finances.

As you learn about credit card interest, think about taking your next step in financial confidence. Best Egg Financial Health could provide you with resources to help you understand your current credit situation and plan for tomorrow with confidence.

What is credit card interest?

Basically, interest is what a credit card user pays to borrow the amount they’ve charged. A credit card charge is a loan, after all. Credit card interest rates vary based on several factors, including the card issuer’s policies and the user’s credit scores.

What is APR?

APR stands for annual percentage rate. The APR charged by a credit card company is the total cost you pay per year for charging purchases or borrowing money. The APR is expressed as a percentage of your loan and includes any fees you are charged, which are not reflected in the interest rate alone. Many credit cards don’t have the fees that typically come with mortgages, auto loans, and other loans. When there are no additional fees or costs, the APR and the interest rate are the same.

How do card issuers decide what interest rate to charge?

Typically, issuers look at an applicant’s credit score and credit report. They will also factor in their costs of providing any perks you’ll receive, such as airline miles or cash back. Other factors include the prime rate, market conditions, and how many users the card issuer desires per specific credit card.

That means interest rates for the same credit card can vary from person to person and even from day to day.

When do I start paying interest on a purchase?

Understanding when a credit card company starts charging interest could help you keep your credit card bill under control. Does interest start to accrue the moment you make a purchase? At the end of a billing cycle? Some other time?

Many credit cards offer a grace period during which they don’t charge interest for new purchases. This means that you don’t start paying interest right away. Many credit cards have a 21-day grace period between when the monthly statement is generated and when payment’s due.

This means that many credit card companies don’t charge interest until 21 days after your payment is due for that billing cycle. The time when you must start to pay interest varies, so check with your credit card company for your credit card’s terms.

Not sure what your monthly statement period is? Call your credit card issuer and ask how your billing period works. Statement dates are usually the same each month.

Where can I find the interest rate for my account?

The rate your credit card issuers are charging you can be found in 2 places. First, check the disclosures your credit card company gave you when you opened your credit account. Don’t have the disclosures? Your rate is also typically found on your monthly credit card statement. 

How does interest on a credit card get calculated?

Because the balance on your credit card may fluctuate, credit card companies look at the average daily balance to determine how much interest you owe each month.

To do this, the credit card company adds up your balances from the end of each day in the billing cycle. They divide that amount by the number of days in the billing cycle. Finally, they multiply the total by the card’s purchase APR.

The reason interest charges can add up so quickly is because credit card companies use compound interest. It kicks in when you carry a balance from month to month. The unpaid interest is considered part of your average daily balance. You end up paying interest on any outstanding interest payments. This can balloon quickly. You may find yourself with a surprisingly high statement balance if you don’t understand compounding interest charges.

Will my interest rate change?

Whether or not your interest rate will change depends on the terms set by your credit card company. Some cards have fixed APRs and some have variable APRs. Variable APR cards are more common than fixed APR cards.

With a fixed APR, your interest rate will not change over time. With a variable APR, your interest rate can change. The rate often is tied to the rate banks offer to borrowers with the best credit, known as the prime rate.

Credit card APRs impact how much interest you pay each year, so it’s important to know which type of APR your card has. Even if you open a card with a low APR, it could increase dramatically if it’s a variable APR.

Can a card have more than one interest rate?

Credit cards can have more than one interest rate, depending on how they’re used. Even the rare card that is billed as having a fixed interest rate can have triggers that cause that rate to change.

A financial institution must give you notice before it changes your interest rate. This means it’s important to read any information your credit card issuer sends you. Here are some of the different rates a consumer might see.

Purchase rate

The purchase rate is the interest charged on credit card purchases that are not paid off before the card’s grace period ends. This is what consumers typically think of when they think about interest rates for credit cards.

Cash advance rate

Some features of your credit card, like a cash advance, may be charged at different interest rates. It is common for credit card companies to charge a higher APR for cash advances. They may also charge cash advance fees and use a different grace period than for purchases. As a result, cash advances might immediately start to accrue interest.

Penalty rate

If you charge more than your credit limit permits, your card may assess a penalty APR. It’s usually far higher than the credit card’s standard interest rate. Lenders also might increase your rate if you have regularly late monthly payments or miss more than one payment.

Balance transfer rate

Sometimes consumers transfer unpaid credit card balances from one credit card to another. This could result in the card holder paying one interest rate on the unpaid balance amount transferred and a different rate on new purchases. Be sure to check if the card you are transferring a balance to charges a balance transfer fee, though.  

Introductory rate

Some credit cards try to attract new users by offering a low introductory rate. This can be a great deal but take note of when that introductory period ends and what the new rate will be.

How can I pay less on interest charges?

The best way to avoid paying interest is to pay your full statement balance each month. That way you won’t accrue interest. However, this may not be realistic for you. If you can’t pay off your outstanding balance monthly, there are other ways to avoid interest—or pay less of it.

Negotiate a lower rate

Try to negotiate a lower interest rate. It’s more likely to work if you’ve had the same credit card account for a long time, have a history of making consecutive on-time payments, and have a high credit score. Pull your credit report to see what card issuers will see. You can check your credit history and see what may work in your favor when you talk with your card issuer at Best Egg Financial Health.

Apply for a low-interest card

Shop around and apply for a credit card with a lower interest rate. (Just remember that applying for a new card may impact your credit score!)

Use a 0% introductory offer

Many cards offer a 0% introductory rate for new purchases–but only for a limited time. This is a great way to pay less (or nothing) in interest, especially on big purchases. Some cards offer 0% interest on balance transfers, too. You can transfer an existing balance from a card with a high interest rate to one with a 0% rate. If you can pay off your credit card’s balance before the new card starts charging interest, that could mean a lot of savings for you. Just remember to factor in the new card’s post-offer interest rate and terms.

Pay more than the monthly minimum

Bring total interest charges down by paying more than the minimum amount due each month. The monthly minimum listed on your bill barely touches the principal. Paying more each month may help to cut down on the amount of interest you end up paying and shorten the time it takes you to pay off your balance.

Shop smart

Being an informed credit card consumer could save you money over time. While shopping for the right card for you, don’t stop at credit card interest rates. Consider the whole picture carefully, including your circumstances, goals, and options. Some people may even find it best to refinance a high-interest credit card balance with a personal loan. Whatever your plan, start by gathering information and forming good habits now, so you can confidently work toward your financial goals.

Published

October 25, 2022

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