Saturday, December 3, 2022

How Do Credit Card Interest Rates Work

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Purchases Vs Cash Advances

How Credit Card Interest Works: The Math

When you use your credit card, interest is charged differently on purchases, cash advances and balance transfers.


Interest on your purchases is not charged immediately. If you pay your closing balance in full by the due date, there is no interest to pay on purchases. Interest accumulates daily and will be charged on your next statement if you havent paid your closing balance in full by the due date. The interest will continue to add up until the total balance is paid.

Cash advances including quasi-cash

If you withdraw cash on your credit card or use your credit card to purchase goods or services that are similar or easily converted to cash , interest is charged from the date of the transaction until the date you pay the transaction off in full. The interest rate on cash advances is usually higher than the rate on purchases.

Examples of quasi-cash transactions

The most common types of quasi-cash transactions include:

  • making gambling transactions or topping up online gambling accounts
  • sending money to another person, for example money transfer or telegraphic transfer
  • purchasing foreign currency or travellers cheques
  • topping up funds on a rechargeable gift card or prepaid card and
  • buying cryptocurrency and securities

Transactions that are not considered quasi-cash include:

  • topping up prepaid mobile phones
  • topping up prepaid transport cards
  • purchasing raffle tickets and
  • making donations to charities.

What Is A Good Purchase Apr For A Credit Card

Ideally, you want the APR on any card where you carry a balance to be somewhere between 12-17%. Of course, you will need excellent credit to qualify for such low rates, even on low interest cards. If you have fair or good rate, you at least want to aim for a credit card APR of 20% or less.

The reason for this is that you want the lowest APR possible to apply to a balance that you pay back over time. Reward credit cards are less rewarding if you allow interest charges to apply. In fact, the value of any rewards you earn are usually offset by interest charges within the first 2-3 billing cycles. Ideally, you should pay off reward balances in-full every month to avoid interest charges entirely.

But for big purchases or expensive times of the year , use your lowest APR credit card. That way, you throw less money away on interest charges.

How To Calculate Credit Card Interest

Calculating credit card interest is a three-step process. The video above walks you through that process in detail, but here’s a general overview of how it works. If you want to follow along, grab your credit card billing statement. You’ll need some information from it.

1. Convert annual rate to daily rate

Your interest rate is identified on your statement as the annual percentage rate, or APR.

Since interest is calculated on a daily basis, you’ll need to convert the APR to a daily rate. Do that by dividing by 365. Some banks divide by 360 for our purposes, the difference isn’t worth worrying about, as it changes the outcome by only a hair. The result is called the periodic interest rate, or sometimes the daily periodic rate.

» MORE: Does your credit card’s interest rate matter?

2. Determine your average daily balance

Your statement will tell you which days are included in the billing period. Your interest charge depends on your balance on each of those days.

You start with your unpaid balance the amount carried over from the previous month. When you make a purchase, the balance goes up when you make a payment, it goes down. Using the transaction information on your statement, go through the billing period, day by day, and write down each day’s balance.

Once you’ve got that done, add up all the daily balances and then divide by the number of days in the billing period. The result is your average daily balance.

3. Put it all together

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How To Calculate Your Interest

Many people arent familiar with how to calculate credit card interest, but understanding how credit card interest works can help you do the math.

Most credit card interest compounds on a daily basis. This means that your daily credit card interest rate can be calculated by taking your APR and dividing it by 365 . This number tells you the amount of interest your issuer charges every day when you carry a balance on your credit card.

Lets say you have an APR of 16.99 percent. That would place your daily interest rate at approximately 0.05 percent. If your balance at the beginning of your billing cycle is $100, your balance will rise to $100.05 by the end of the day. The next day, youll be charged 0.05 percent interest on your new $100.05 balance, increasing your balance to $100.10 . Interest will continue to compound in this way until you reach the end of your billing cycle.

This example assumes that no new purchases have been made during the billing period. Lets say you add a $25 purchase to your $100.10 balance. That brings your balance up to $125.10, and at the end of the day, youll accrue 0.05 percent interest on the entire amount, making your new balance $125.16 .

What Is A Good Interest Rate For A Credit Card

How credit card interest rates work

Credit card interest rates vary widely, which is one reason to shop around if you’re looking for a new card. Typically, the better your credit, as represented by your , the better the rate you’ll be eligible to receive. That’s because the credit card company will consider you to be less of a risk than someone with a lower score.

In shopping for a credit card, knowing your credit score and the range into which it falls can help you determine which cards and what kinds of interest rates you might be eligible for before you apply. You can obtain your credit score for free at a number of websites and also from some credit card companies. Note that your , which you can also obtain free of charge at, do not include your credit score.

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How And When Is Credit Card Interest Charged

Eric is a duly licensed Independent Insurance Broker licensed in Life, Health, Property, and Casualty insurance. He has worked more than 13 years in both public and private accounting jobs and more than four years licensed as an insurance producer. His background in tax accounting has served as a solid base supporting his current book of business.

Most people aim to keep their credit card cost at $0, especially rewards credit card users who work to optimize their credit card perks. Getting a credit card with no annual fee is a start at minimizing credit card costs. However, if you carry a balance, you could still incur a cost in the form of interest. Knowing how and when credit card interest is charged is the best way to avoid paying interest and keep your credit card free.

Your credit card issuer will charge interest whenever you carry a balance beyond the grace period. Credit card interest isn’t a one-time thing either. Each month you carry a balance over from the previous month, youll have a finance charge added to your balance.

You won’t be charged interest if a 0% promotional rate applies to your balance.

Should You Use A Cash Advance To Pay Down Credit Card Debt

A cash advance is when you use your credit card to withdraw cash from the automatic bank machine or write a cheque the credit card company conveniently provided.

Obtaining cash from your credit card usually incurs a higher interest rate and theres no grace period so the daily compounding interest begins immediately at the higher rate on the amount you have withdrawn.

So as a way to get out of debt, its not a good strategy.

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How To Calculate Your Daily Apr On A Credit Card

Your credit card company may calculate your interest with a daily periodic rate.

Calculate your daily APR in three easy steps:

  • Step 1: Find your current APR and current balance in your credit card statement.
  • Step 2: Divide your APR rate by 365 to find your daily periodic rate.
  • Step 3: Multiply your current balance by your daily periodic rate.
  • Q: First Things First: What Are Credit Card Interest Rates

    Credit Card Interest Rate Explained | How Does Credit Card APR Work?

    A: Anytime you use your credit card, youre essentially taking an unsecured loan. Interest is what you pay for borrowing that money and not paying back the whole balance yes, all of it within a specific time period.

    The key number to know is your annual interest rate . This refers to the annual rate of interest that would be charged over a year, and is sometimes referred to as annual percentage rate . A low-interest credit card may have an interest rate of 12.99% or less, while other credit cards may have a higher one. Take a look at your monthly statement: You should see your AIR clearly indicated for purchases and for cash advances . Well get into the differences between those rates later.

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    How Credit Card Interest Is Determined

    Your creditor determines the interest rates for your credit account by looking at your credit history and annual income. When you apply for a credit card, your issuer will do a hard credit inquiry into your credit report. This will allow it to see your credit score, payment history, number of credit accounts and other valuable information about the way you use credit.

    Your issuer will use this information to determine whether to issue you a credit card, as well as what your credit limit and interest rates will be. People with higher credit scores usually qualify for lower interest rates. Thats why it can be a good idea to improve your credit score before applying for your next credit card.

    According to the , credit card issuers are required to give you 45 days notice before raising your interest rates . Your interest rates might go up if your credit score goes down, for exampleor you might miss a payment and get stuck with a penalty APR. Your credit card issuer can also lower your interest rates at any time. A decrease in your interest rates might be related to an increase in your credit score, or it might be linked to a debt management plan.

    Learn more: What is a good APR for a credit card?

    Why Pay Your Balance In Full

    As an investor, you would be thrilled to get a yearly return of 17% to 20% on a stock portfolio, right? In fact, if you were able to sustain that kind of return over the long term, you should probably be running your own hedge fund.

    Paying off a credit card balance is much like getting a guaranteed rate of return on your investment. If your credit card charges 20% interest per year and you pay off the balance, you are guaranteed to save yourself 20%, which, in a way, is the equivalent of making a 20% return.

    So, when you have some cash to spare, it is almost always better to use it to reduce your credit card debt than to invest it. If you can pay off your balance and stop paying credit card interest altogether, you’ll find you have more money to invest in the future.

    One interim strategy to consider, if you’re eligible, is transferring your current credit card balances to a balance transfer credit card with a lower interest rate. Many of these cards have promotional periods of six to 18 months over which they charge 0% interest on your balance, which can stop the clock on further interest charges and allow you to pay your balance down faster. Just watch out for any balance transfer fees, which can add 3% to 5% to your existing balance.

    And, whatever you do, remember to keep paying!

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    Purchase Rates And Cash Advances

    Generally, the APR quoted for each card only applies to purchases made, rather than cash withdrawn.

    Using your credit card to make a cash advance normally comes with much heftier rates and charges and so you should really only do so when it is absolutely necessary.

    Where possible, you should stick to making purchases with your credit card and, if you need to withdraw cash, use your debit card instead.

    How To Save On Credit Card Interest

    Understanding How Credit Card Interest Works

    Track your spending

    Whether or not you currently carry a balance, keeping track of your credit card spending is crucial.

    If you are carrying a balance, youâll also want to limit your card spending and opt for cash instead until you clear off your balance.

    Schedule regular payments to your credit card

    You donât need to wait for your statement to arrive in the mail before paying down what you owe. Instead, make multiple payments per month to chip away at your balance faster.

    Arguably the simplest way to do this is by setting up automated payments from your chequing account to your credit card. That way, you wonât forget to make payments and youâll guarantee that some of your money is being put towards your credit card debt before you spend it on something else.

    Donât go overboard here though, because if youâre not careful you may end up withdrawing more money than you have and get hit with overdraft fees. So, ensure your payments are consistent but manageable.

    Using a balance transfer credit card

    If you currently have a large balance on your credit card, youâre likely paying an interest rate of upwards of 19.99%. What if you could pay 0.99% or 3.99% instead? By using a balance transfer credit card, thatâs a possibility.

    Use a low-interest credit card

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    Are You Allowed To Decline Or Approve A Credit Card Application If The Interest Rate Is Too High

    If you wish to decline a credit card application because the cards interest rate is too high, you might be able to do so by contacting the card provider before they make their decision. Once your application is approved, you can get the card provider to cancel your card. However, doing so will impact your credit score. That effect will be minimal if you have an excellent credit score, but it could be more significant if you have average or poor credit.

    Two Ways To Avoid Paying Interest Fees

    If you dont relish the idea of paying an additional $100 a month on purchases simply for the pleasure of making them with your credit card, youre hardly alone. About 30% of Americans have yet to adopt the credit card, many of whom cite interest fees as a reason for abstaining.

    Thankfully, you may have several options for avoiding paying interest fees on your credit card, both for short-term and long-term balances. Which method you select may depend on both your personal spending behaviors and current level of creditworthiness.

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    How To Lower Your Credit Card Interest Rate

    There are two ways to lower your credit card interest rate. If you improve your credit score, your credit card issuer might lower your interest rate automatically. This will probably get you a lower interest rate on any new credit cards you apply for, too. The other way to lower your credit card interest rate is by contacting your credit card issuer and asking for a lower interest rate. If you have a history of on-time payments and responsible credit use, you might be able to request a lower rate in exchange for being a responsible cardholder.

    If you are struggling with credit card payments, you might be able to get a lower interest rate by contacting your credit card issuer and negotiating a debt management plan. You might also want to consider working with a reputable debt relief company that will contact your credit card issuers and negotiate lower interest rates on your behalf.

    Why Interest Rates Are Not Always Applied

    How Does Your Credit Card Interest Work?

    In some cases, card issuers do not apply interest charges. For example, if you have no balance from one billing period to the next, you will not be charged any interest. Many card issuers even offer a grace period of up to a month without charging interest, starting from the date your bill became available to the day payment is due. But you can lose this grace period if you have an outstanding balance on your payment due date. This is known as a revolving balance, but you can avoid the interest charges if you pay the balance in full on your previous two bills by their due dates.

    If you do receive an interest charge after paying your balance to zero, this could be a mistake on your card issuers part. However, most of the time, these charges happen because cardholders misunderstand part of how credit card interest rates work. If you start a new billing cycle with a revolving balance, you accrue interest each day. If you pay your original balance, this will no longer be enough to bring it to zero. Instead, you will still need to pay the interest that accrued from the day your bill became available and the day you paid it.

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    How To Calculate Credit Card Apr Charges

    Understanding how your credit card’s Annual Percentage Rate is calculated and applied to your outstanding balances is crucial to maintaining control over the growth of your overall credit card debt. Your credit card’s Annual Percentage Rate is the interest rate you are charged on any unpaid credit card balances you have every month. By figuring out the daily periodic rate on your credit cards, you can have a better understanding of how compound interest is affecting how much you’re paying back in interest. Your monthly statement may break down your APR yearly or monthly on your monthly statement, but you can break it down to a monthly APR yourself. This information could help you make decisions about which credit cards you may want to focus on paying down quickly and how much it is costing you each day to borrow from your credit card company. Monthly APR can also help you understand how much it is costing you to carry a balance each month that you are not paying down the entire balance.

    Below, you will find steps and formulas for calculating both your daily and monthly percentage rates, which are based on your APR, and how they are applied to your balances.

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