Understanding how credit card interest rates work can make the difference between paying or not paying interest. Yes, there are maneuvers you can make to not pay interest or at least reduce them, which we point out below.
But first, let’s get a simple understanding of how and when credit card interest is charged.
When credit card interest is and isn't charged?
You may have heard of the term cycle period. It's the beginning and end of a spending period, which typically works out to be one month. For example, the 1st – 30th April is considered a cycle period.
After a cycle period has ended, the bank will issue a customer with a credit card bank statement. On the statement, it will show the cycle period date and the amount spend on the card during the cycle period. Totaled up are all transactions made during the month and set as the closing balance.
Besides the closing balance is the minimum payment on the statement. Also, is the payment due date, which is set at 15 to 25 days after the cycle month. Also known as the number of days the bank gives the cardholder to make a payment.
Now, that we have all the above banking jargon explained, let’s get into when interest is and isn’t charged.
An example of when credit card interest is and isn't charged.
Tom’s cycle period is between April 1st to 30th. Made a purchase of $1,000 on the 10th of April. At the beginning of May, he receives his credit card statement that shows a closing balance of $1,000 and the payment due date of 25th May.
Does not get charged interest: He pays $1,000 towards the credit card before the payment due date, thus he isn't charged interest. When the whole closing balance is paid off before the due date, no interest is charged.
Gets charged interest: In this scenario before the due date, Tom instead makes a payment of only $600 towards the credit card, which leaves a $400 outstanding balance on the card. This now means that starting from 26th May, the $400 outstanding will incur daily interest until he pays it completely off.
How to calculate the interest on your credit card
Doing the math and calculating the interest can get a bit tricky.
The first thing to understand is that credit card interest is calculated daily on the balance. So we have to figure out the daily interest rate and each day’s balance.
Jane carries an unpaid balance of $300 from the previous month into May. Then makes one purchase of $500 on the 20th of May. This means that from 1st to 19th May (19 days) the balance was $300, then from 20th to 30th May (11 days), the balance was $800.
What's her card's daily interest rate? The annual percentage rate on Jane’s credit card is 22% p.a. To find out the daily rate, there are 365 days in the year so we divide the rate by 365 days. 22/365 = 0.06% daily rate.
Let’s then convert 0.06% to a decimal, 0.06/100 = 0.0006.
Now we do (balance 1 x daily rate x days 1) + (balance 2 x daily rate x days 2)... = interest amount.
Then we get (300 x 0.0006 x 19) + (800 x 0.0006 x 11) = 3.42 + 5.28 = $8.70 interest.
How do interest-free days on credit cards work?
Interest-free days are the number of days of getting no interest on purchases.
You may have always wondered why the word “up to” is used together with interest-free days. It’s common to see up to 55 days interest-free on credit cards in the market.
The number of interest-free days is calculated from the starting first day of the cycle period to the payment due date.
Let’s say our spending period or cycle period starts from June 1st and ends on June 30th, which amounts to 30 days. Then at the beginning of July, we receive the credit card bank statement, which shows that the payment due date is on the 25th of July (25 days).
Starting from 1st of June to 25th July is 55 days, which is why it’s up to 55 days interest-free.
Purchases made earlier in the month will receive more interest-free days than ones made later.
Tips for reducing your credit card interest
After understanding how credit card interest is charged, you may have caught onto an idea of how to reduce your interest rate charges during a single month. That way is to pay down the balance as much as possible during the month, rather than waiting to pay once you receive the statement balance.
Keep in mind, when making repayments during the month to reduce your balance, you still have make to the minimum payment by the due date as per the statement. Because repayments made during the cycle don’t count towards the minimum payment.
Or if you’re currently paying interest and planning for a particular month to make a purchase, then make that purchase towards the end of the month so that it has fewer days on interest.
How to find low rates credit cards online
Depending on your financial situation, there are a few different low or zero interest credit cards to choose from to save on interest. Pick either a low rate credit card, interest free offer, no interest card or a balance transfer offer.
If you anticipate not be able to pay the closing balance after each month before the due date, then you should have a few different credit card options available.
Low Rate card. Out of the different types of credit cards to pick from, usually, a low rate card is a good option. Try and find the lowest rate credit card possible, sometimes you may even find one with free extra benefits.
Interest-Free Offer. This type of offer provides 0% interest on purchases for a set number of months. The number of months varies, can sometimes be up to 24 months. Interest free offer credit cards are a good idea, especially for bigger ticket home goods purchases.
No interest card. A new type of credit card that hit the market in 2020 is the no interest card. Never pay interest forever. There are monthly fees and minimum repayments required on these cards. The good news is that if you don’t use the card with a zero balance during a month, then the monthly fee is waived.
Balance Transfer Offer. Those with existing credit card balances and having difficulty to wipe them off could be considering a balance transfer credit card offer. By transferring an existing balance over to another bank can get zero interest on their balance transfers on some offers for up to 36 months. A good way to stop paying interest and attacking the credit card debt.
Or if you find yourself with outstanding balances on several credit cards, then transferring their balances over to one balance transfer card. This will simplify things by giving you only one repayment to remember each month.
What’s the deal with credit cards having such high interest rates?
Credit cards are unsecured lending in the form of credit. There is no collateral held against a credit card. Unlike a home loan, which is secured by a property, thus having lower risk and thus lower rates.
But with credit cards, there is no secured collateral, which makes it a higher risk product. Because of the greater risk that comes with a credit card, their interest rates are set higher.
Things you can do to manage credit card interest better
• Quickly pay off as much of the balance as possible during the month, rather than leave it to the due date, because credit card interest is charged daily.
• Set up auto payments to pay off your card, so you don’t forget and miss a payment.
• Use credit cards responsibly. It may be tempting sometimes, but exercise restraint and only purchase things you can afford to pay back.
• Put a spending cap or low credit limit. Put these limits in place is the first line of defense when sometimes we can make impulsive purchases or shopping sprees.
• Block cash advance withdrawals. This charges the highest interest rate and right from the outset, it offers zero interest days. Instead, may look to a family member or friend to borrow cash from.
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