What You Need to Know About Credit Card Interest
When applying for a credit card, there is no doubt that the interest rate charged is one of the biggest consideration. Comprehending the mathematics behind these rates will put you in a position to access how expensive or affordable your credit card is going to be. Regardless of how important this information can be, many people still don’t understand how credit card interest works which leaves them prone to making misinformed decisions when time to select a credit card comes. By the end of this blog post, you will have learned all you need to know about credit card interest.
First things first, what is credit card interest?
Whenever you use a credit card to make a purchase, you are borrowing money from your credit card company. As a result, all the credit card expenditures have to be repaid to this company in full on an agreed date. If you fail to pay in full or you opt to only pay the minimum agreed amount, interest is going to accrue on the balance. The accrued interest rate is the money you compensate your credit card company for lending you money.
To make it easy to understand this concept, think of a credit card interest as a mortgage interest. The goal is rewarding your credit card company for giving you access to money that you never had. If you do not have the capacity to repay in full, the company has to be repaid in bits as you look for money to repay them in full. When is the interest charged? If you can repay all of your credit card balance monthly, no interest is going to accrue on your card. However, don’t get fooled by the minimum amount on your credit card. If you want to avoid interest accruing on your card, ignore it or you could find yourself entangled in debt for years if not decades. For instance, let’s imagine you have a $ 1000 balance with your credit card company which charges you an interest rate of 15%. If you opt to pay only the minimum payment, it is going to take you almost 9 years to pay the balance and you will also end up paying an extra $700 in interest payments. However, if you can pay in full, no interest is going to be charged to you.
How is the credit card interest calculated?
Using out our example above, what does a 15 percent interest rate imply? Well, first and foremost, let me make it clear that when we talk about an interest rate, we are referring to the credit card APR which is calculated on an annual basis. However, just because our case study has a 15 percent APR doesn’t imply that you owe the company only $150. As a matter of fact, you owe them more. Credit APR is calculated using compounded interest. The 15 percent is more of a sticker rate. What you owe the company is actually calculated periodically. It is also known as the average daily periodic rate which is arrived upon by dividing the interest rate by the number of days in years which is typically 365. In our case, we should divide 15 by 365 which gives us a daily periodic rate of 0.04 percent. This is what you are charged on your credit card balance on a daily basis. For this reason, the final interest expense you will incur will be significantly higher than the charged rate because the charge stacks on top of itself on a daily basis.
What impact does a late payment have on your credit card interest rate?
If, for any reason you make late payments – whether partial or in full, your credit company might charge you a fine or even raise your credit card APR. If you take a keen look at your credit card statement, you will find a disclaimer stating that the company has the right to raise the interest rate in case of late payments. Being late for even a single day could trigger a lateness fee or an increase to your credit card APR which could end up costing you thousands of dollars. The only way to avoid these penalties is by making your minimum payments on time or calling the company to ask for a reprieve if that has already happened.
The Bottom line
The best way to avoid interest from accruing on your balance is making full payments on your credit card balance. Keeping your credit scores high will also help you in getting lower interest rates on your credit card. Creditworthy customers receive the best credit card APR rates from credit card companies.