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How Credit Card Interest Works

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What Is Credit Card Interest And Why Does It Matter

How Credit Card Interest Works: The Math

You can think of APR as the cost of borrowing money. The credit card issuer covers the cost of your purchases upfront, while you get to pay them back over time. In exchange, they charge you a fee for this service in the form of interest.

Credit card interest is generally described in terms of APR, which stands for;annual percentage rate. However, credit card interest is actually calculated on a daily basis and then charged monthly at the end of a billing cycle.

To understand how much a purchase made with your credit card will really cost, you need to understand how interest is calculated and when it is applied. That way, youll know exactly how much interest youll pay on your credit cards.

For example, if you wanted to pay off a $2,000 purchase over 24 months, you might end up paying closer to $2,400 when you factor in interest charges. This may be worth it to you, or maybe you can be more aggressive with your payments and save, say, $150 in the long run.

Interest And Apr: A Simple Definition

Most credit cards come with an interest rate. Simply put, this is the price youll pay for borrowing money.

For credit cards, interest is typically expressed as a yearly rate known as the;annual percentage rate, or APR. Though APR is expressed as an annual rate, credit card companies use it to calculate the interest charged during your monthly statement period.

How Does Credit Card Interest Work

You may know your credit card will charge interest if you don’t pay off the balance each month, but do you know how that credit card interest actually works? Credit card interest is calculated based on an account’s average daily balance during the statement period, and is compounded daily. However, interest charges are usually waived when cardholders pay their entire statement balance by the due date. Here’s what you need to know about how credit card interest works.

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How Does A Purchase Apr Work

The purchase APR is the rate of interest the credit card company charges on purchases you make with the card if you;carry a balance;on the card, which is what its called when you dont pay off your balance on your monthly statement and roll it over onto the next months bill.

But some credit cards come with purchase APR promotions that offer an introductory purchase APR or;low interest rate;on new purchases made with the card for a set amount of time. You may see intro APRs for purchases that last anywhere from just a few months to 21 months or more.

An introductory purchase APR offer can give you a way to pay off new purchases at a lower interest rate, sometimes even;as little as 0%. Once the promotional time frame ends, the regular purchase APR will take effect. This is usually a higher interest rate that youll begin paying on both new purchases;and;existing purchases that you havent paid off before the intro period ended.

How To Stay In Control Of Revolving Credit

How Does Credit Card Interest Work?

A few simple steps can help you pay down a revolving balance and might even help your credit score moving forward.;

  • Spend responsibly. This is a good tip whether you carry a revolving balance or not. But if you do have a balance, make sure to keep in mind what you already owe when you think about spending more.;
  • Pay more than the minimum. Whenever possible, pay more than the minimum amount due. It might help you lower your balance more quickly.
  • Consider paying off higher interest accounts first. Because these debts are costing you the most money, it might be a good idea to increase your payments to your higher interest accounts.;
  • Make all payments on time. By steering clear of late payments, you can avoid late fees. And you might even be able to help boost your credit score by consistently making on-time payments.
  • Monitor your credit score. Did you know youâre entitled to;free credit reports from each of the major credit bureaus? Learn how to get free copies of your credit reports from AnnualCreditReport.com.
  • You can also monitor your credit score with . CreditWise is free for everyone and alerts you when something meaningful changes on your TransUnion® and Experian® credit reports. You can access your report and weekly VantageScore® 3.0 credit score anytime, without negatively impacting your score.

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    Different Types Of Interest And Apr

    There are other details in your cards fine print you should review to understand how much you could pay in fees if youre not careful. Heres what you need to know.

    A credit card can either have a fixed APR or a variable APR. A;fixed APR;typically remains the same, but it can change in certain circumstances, such as if your payment is more than 60 days late or when an introductory offer expires. A;variable APR;usually changes with the prime rate, as published in the Wall Street Journal. Many variable interest rates start with the prime rate, then add a margin. The result is your variable APR.

    The purchase APR will be used to calculate how much interest youll pay on an outstanding purchase balance, if you have one. If you have excellent credit , you may be more likely to qualify for a lower interest rate because a credit card company may consider you a lower-risk customer.

    If you have fair or poor credit , you may get a higher interest rate if youre approved for the card. This means itll cost you more every time you carry a balance with your card, so be sure to pay off your balance on time and in full every month, if possible.

    Different Types Of Interest

    There are many different types of interest, and your credit card may charge different interest rates for purchases, balance transfers and cash advances. Learning about these interest rates will help you understand how credit card interest worksand might help you avoid paying interest on your credit cards.

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    How Long Before Interest Is Charged On A Credit Card

    Most credit cards provide an interest-free grace period of around 21 days starting from the day your monthly statement is generated, to the day your payment is due. However, if you don’t pay it during that time, an interest charge will go into effect and you will end up with a balance that rolls over to the next month.

    Transferring Your Balance To A New Card

    How Credit Card Interest Works (Credit Cards Part 2/3)

    You have seen and no doubt been tempted to get a new credit card with a lower introductory rate if you transfer your current credit card balance.

    This certainly could work for you if you have a plan and the discipline to not increase the balance on the new card, cut up or stop using the card you have just transferred the balance from and aggressively pay down the amount owed versus making the minimum monthly payment.

    The first thing to check before transferring the balance is the length of time the low-interest introductory offer lasts and if you think you can realistically pay down the majority of the debt during that period.

    Then you need to understand what the rate will be when the introductory offer is over and estimate what your balance will be at that time.

    The standard rate on the new card may be greater than the old card and ultimately cost more in the long runplus you need to confirm if there are any transfer fees or additional costs.

    Remember, if you use the new card, new purchases made will be charged at the standard interest rate as the introductory rate is only for balance transfers. Any payments you make will be applied to the amount transferred not the new purchases.

    Did I miss anything? Any other questions about how credit card interest works in Canada? Leave your question in the comment section and Ill respond.

    Forewarned is forearmed!

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    How Do I Pay Off My Credit Card

    Even if you cant pay off your balance in full, it can be helpful to pay more than the minimum payment to work towards being debt-free. To do this, we recommend coming up with a budget plan so you can better understand how youre spending your money, and how you can cut costs. Even an extra $5 or $10 a month can help you pay less in interest, and may make more of an impact than you might think. Learn More:;How to Pay Off Credit Card Debt

    Between Rewards Programs And Greater Financial Flexibility Credit Cards Have A Lot To Offer But If You Dont Know How Credit Card Interest Works Youll Have A Hard Time Maximizing Your Cards Benefits

    In an ideal world, youd never miss a monthly payment or carry a balance on your credit cards. But many Americans do carry a credit card balance from month to month. According to the Federal Reserve Bank of New Yorks Household Debt and Credit Report from the second quarter of 2020, credit card balances stand at approximately $820 billion.So, whats the problem with carrying a balance and having credit card debt? In many cases, it boils down to three letters: APR.

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    When Does Interest Start To Accrue On A Credit Card

    Understanding how you’re charged interest on your credit card is the key to knowing how to manage your card debt. Here’s how it works.

    DPR is just another way of saying what your daily interest charge is. That’s calculated by taking your credit card’s Annual Percentage Rate and dividing it by 365, for all the days in the year.

    So if your card has a 15.99% APR, your DPR would be 0.0438%.

    The reason why credit card balances can quickly build up on cards with high APRs is because of compounding interest charges that occur on a daily basis.

    At the end of each day, the interest charge is calculated and added to your balance for the next day. This continues every day for the billing period, so the interest you’re charged one day becomes part of the balance on which interest is charged the next day, and so on. At the end of the month, the lender will add up all of these daily interest charges and put it on your card as a finance charge.

    How To Stop Paying Interest

    How does credit card interest work?

    The easiest way to avoid paying interest is to always pay your statements closing balance on time, and not make any cash advances.

    If you have been paying interest on purchases, you can regain your interest-free period by:

    • Paying your;account balance;in full to get interest-free on all purchases from that day.1;This is everything you owe up until today, including any purchases youve made since your last statement.2;
    • Paying your;closing balance;in full by the due date shown on your statement to get interest-free on new purchases in your next statement period. This is the amount you owe from your last statement period.

    Remember, the sooner you pay off everything you owe, the less interest youll need to pay you dont need to wait until the due date.;When you pay your account balance in full its important to remember that any interest accrued from the start of your statement period, up until the time we receive the payment, will be charged to your next statement.;

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    How To Avoid Paying Credit Card Interest

    Of course, none of these interest rate calculations are relevant if your card issuer waives the interest charges. Nearly all card issuers won’t impose interest charges when the entire statement balance is paid in full on or before the due date. The period of time between the statement closing date and the due date is called a grace period.

    Technically, interest charges apply during this period, but they are waived if the entire balance is paid in full and on time. By law, credit cards that offer a grace period must give you at least 21 days to avoid interest by paying your balance in full. For more information, see “What Is a Good APR for a Credit Card?”

    How To Close A Credit Card Account

    Both the primary cardholder and the credit card issuer are able to close a credit card account at anytime. However, if your card has an outstanding balance at the time the account is closed, you are still responsible for paying it off in full.

    One last thing to keep in mind is that part of what makes up your credit score is the length of time you have been building your credit history. For that reason, itâs suggested that you never cancel your oldest credit card, because itâs been helping you establish your credit history for the longest period of time.

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    What Determines A Credit Cards Interest Rate

    As the CFPB explains, âThe credit card company may decide which interest rate to charge you based on your application and your credit history.â Generally, the higher your credit score, the lower your interest rate might be.

    The interest rate, or APR, can either be variable or non-variable. A variable APR is often based on the prime rateâan index that most lenders use to set their own interest rates. And a variable APR could change when the prime rate changes. A non-variable APR typically stays the same, but it can change under certain circumstances. For example, your non-variable APR could increase if you make late credit card payments or miss payments, depending on your card issuerâs policy and your card terms.

    A credit card may offer an introductory or promotional APR on purchases and balance transfers. After the introductory or promotional period ends, the rate will return to the standard APR disclosed in the cardâs terms.

    If The Steps Above Seem Confusing Here’s An Example Of How To Calculate Apr Charge On A Credit Card:

    How Credit Card Interest Works (How To Calculate)

    If your current balance is $500 for the entire month and your APR rate is 17.99%, you can find your daily periodic rate by dividing your current APR by 365. In this case, your daily APR would be approximately 0.0492%. By multiplying $500 by 0.00049, you’ll find your daily periodic rate is $0.25. In order to calculate the monthly interest charges to your balance you simply need to multiply this daily periodic rate by the number of days in your billing cycle. For most credit cards the average billing cycle is about 30 days.

    With this in mind, it is prudent to keep on top of payments each month in order to minimize this effect of daily compounding interest.

    The steps above will put you on the right path to not only learning how to calculate APR on a credit card, it will also assist you in learning how to use your credit card efficiently.;

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    How Credit Card Interest Is Calculated

    An average daily interest rate doesnt seem like much. But if you dont pay your entire statement balance by the due date, youre charged interest on the unpaid amount. Some lenders, like CIBC, calculate credit card interest using your average daily balance. Heres how it is calculated:

  • Add the balances for each day together and divide it by the number of days in your statement period. This is your average daily balance.
  • Multiply the APR by the number of days in the calendar year to get your daily interest rate.
  • Then multiply your average daily balance by the daily interest rate , and multiply this total by the number of days in the statement period.
  • The total amount of interest you owe is added to your account at the end of the statement period.

    For example, lets say you have an average daily balance of $500 with an APR of 20%. Your daily interest rate would be 20% divided by 365 days, giving you about 0.054%. To find how much interest you owe each day, multiply 0.054% by $500, which gives you $0.274. To get your total interest charges for the month, multiply your $0.274 by the number of days in your statement period, lets say 30 days. This gives you $8.22.

    Choosing A Low Interest Credit Card

    If credit card interest is a concern, then consider applying for a credit card with a low interest rate. There are a number of options for low interest credit cards available to Canadians and they can be a great option for individuals who need to make a large purchase but dont have the cash on hand. The low interest will make it easier for you to pay off that debt faster.

    To help you choose, Ive put together this list of the best low interest credit cards in Canada.

    Keep in mind, low interest credit cards dont have the same perks and rewards systems as your day-to-day credit cards. So, if you are confident that you can pay off your credit card statements each month then you should consider a travel rewards credit card or a cash back credit card to get the extra benefits.

    If a low interest card makes sense for you, heres one that I recommend.

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    What Is An Apr

    One piece of advice that gets tossed around a lot when it comes to credit cards: Look for a low annual percentage rate . Its good advice, but what does it actually mean?

    According to the;Federal Trade Commission, The APR is a measure of the cost of credit, expressed as a yearly interest rate. It must be disclosed before your account can be activated, and it must appear on your account statements. The card issuer also must disclose the periodic rate the rate applied to your outstanding balance to figure the finance charge for each billing period.

    Translation: An APR is how much the company or bank issuing your credit card can charge you for borrowing money in different ways. There are typically five ways you can use your credit card and your APR may adjust slightly for each. They include:

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