How Is Interest Charged On A Credit Card?

22 NOVEMBER, 2021

Credit cards have changed the way we manage our money during a shortfall. They enable you to make all kinds of purchases without worrying about not having funds. Credit cards are the best way to manage your finances if you use them wisely. However, they put a burden on your budget if you miss making timely repayments.

Every credit card comes with an Annual Percentage Rate (APR). Let’s say your credit card has a 15% APR, it does not mean that you will have to pay an interest rate of 15% once a year. Depending on how you use your credit card, their interest rates may vary. It may increase or decrease, or may even be 0%. The reason is that the credit card interest rate is calculated daily, not annually. It is worth noting that credit card interest rates are charged only if you carry balances from month to month. 

Follow Three Steps to calculate Credit Card Interest Rate

Generally, there are three steps to follow when calculating your credit card interest rate. To do so, you will need to check your credit card statement, which contains critical information.

Here are the steps to follow:

• Convert your APR to the daily rate

Your interest rate is known as APR on your credit card statement. Since your credit card interest rate is calculated daily, you need to convert your APR to a daily rate. Take your APR and divide it by 365. The result you get is known as the periodic interest rate or the daily periodic rate.

• Find out your average daily balance

Upon checking your credit card statement, you will find the days included in your billing period. Your interest rate depends on the balance you carry each day. You can start by noting down the unpaid balance - the amount carried out from the previous month. Whenever you buy something with your credit card, your balance increases. When you make a payment, your balance decreases.

So, go through your billing period, day by day, and note down each day’s balance. After that, you will need to add up all the balances and divide them by the number of days in your billing period. That is how you will get your average daily balance.

• Make final calculations

After determining your average daily balance, you will have to multiply the result by your daily rate and the number of days in your billing period. The result you get will be your credit card interest rate.

The interest rate is compounded daily, and your bank will add the accrued interest into your unpaid balance, ensuring that you are paying interest on interest. Compounding is why you could pay more than your APR in interest.

How does a credit card interest rate work?

Banks will charge interest if you do not make timely repayments of your bills. However, if you pay the balance on time and in full every month, you do not have to incur interest charges. Paying your credit card bills on time and in full is the best way to manage your credit card account. But, if you intend to carry a balance on your credit cards, it is advisable to opt for low-interest credit cards, which can save you a significant amount of money.

A golden piece of advice would be to pay multiple times in a month than once a month. This way, you will decrease your daily balance. A low balance on your credit card also brings down your credit card interest rate.

Depending on your credit card, you may have a single purchase APR for all customers, or your APR may range between 10% to 20%. Your interest rate is determined based on your creditworthiness. The healthier your credit score, the lower will be your interest rate. Generally, the interest rate is tied to the prime rate. So, when the prime rate increases, the credit card interest rate also shoots up. Also, your APR is influenced by the type of credit card you are using. If you have a reward credit card, your APR rate may be slightly higher than other credit cards.

When Interest Rate is Charged On Credit Card

There are several situations wherein you will have to incur interest charges on your credit transactions, such as:

• When you are unable to pay the outstanding dues on your credit cards within the due date

• When you make the minimum due amount payment

• When you pay less than the minimum due amount on your credit card

• When you opt for a cash advance - The interest rate accrues from the date you withdraw the cash up until you repay in full

• When you carry previous months’ due amount to next months.

Conclusion

If you want to save on your credit card, it is better to buy a credit card that comes with no annual fees. However, if you carry a balance from the previous month, you will have to pay interest charges. So, if you know how and when the credit card interest rate is charged, you can easily avoid the cost of interest on your credit card.