How Credit Card Interest Works In 4 Steps
To illustrate how credit card interest works, weâll be using the following simplified example:
- Letâs say you have a credit card with an Annual Percentage Rate of 19.99% and a 30-day billing period
- On day 1 : You carry over $1,000 in money owed and interest from your previous statement
- On day 3: You make a new purchase of $500
- Assuming no additional payments or charges are made on your credit card, how much interest would you owe at the end of this billing period?
Our Repayment Calculator Helps You Pay Us Less In Interest
The longer you take to pay off your balance, the more interest youll end up paying. Just by paying a little more each month, you could clear your balance sooner than you think, and pay less in interest.
Enter your current details into our Repayment Calculator and see the difference a few pounds extra can make.
Why You Might Get Charged Interest With No Balance
Its understandably confusing to get a credit card bill that includes interest charges after bringing your account balance to zero. In some cases, it might end up being a mistake on the credit card companys part. But its most often a simple case of misunderstanding the credit card billing process.
So lets try to set the record straight, starting with a practical example.
Say you didnt pay your last monthly bill in full and owe $500 when your next months credit card statement becomes available on June 1. While you may have until June 30 to submit a payment before its considered late, interest will be assessed based on the average daily balance in the interim. That means the amount you owe will increase with each passing day.
So even if you pay off the full $500 balance by the due date , youll still owe money for the interest charged daily since June 1. As a result, when your new bill becomes available on July 1, your balance will be equal to the interest you racked up the previous month. If you do not pay this amount, you will incur interest on interest and will continue to do so until you have paid two consecutive bills in full, regaining your grace period.
What can you take away from this example?
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The Consequences Of Not Paying Your Bill In Full By The Grace Period
If you donât pay your balance in full by the grace period, youâll be charged interest for each day from when you originally made your purchases â not just from when you received your statement â and will continue to be charged interest each day until you pay off what you owe in full.
For example, letâs say you bought a television on March 3rd and received your statement on March 30th. If you donât pay off your balance in full by the end of the grace period on April 20th, youâll be charged interest retroactively each day starting from March 3rd up until April 20th. Youâll then be on the hook for interest moving forward until you completely pay back what you owe.
Usually, carrying a balance also means youâll accumulate interest on new purchases immediately.
This makes it all the more important to monitor your spending and only use your credit card for purchases you can afford to pay for at the end of the month.
Get A Professional Assessment Of Your Debt Situation
Your job is to educate yourself. If you are carrying a large amount of debt, speak to a professional.
You can find experts by searching in your city. We also have offices across Canada, which you can talk to on the phone, email, or meet in-person.
What does an expert know that you dont? They will teach you about debt restructuring options such as debt consolidation, consumer proposals, informal proposals, and how to approach your creditors with a restructuring offer.
They will also be able to analyze the type of debt you carry and educate you on the right choice for you. You can sometimes reduce your debt with restructuring. For others, bankruptcy might be the right choice.
Heres a list of our offices in your city.
And finally, here are real stories about debt from Canadians who survived their financial crisis.
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How Does Credit Card Interest Work In Canada
This article is by Paul Murphy, our VP and financial literacy expert with 15+ years of investment and banking industry experience.
If youve ever floated a balance on a credit card, youve likely asked yourself: how does credit card interest work in Canada?
The basics seem simple. You borrow money from the credit card company. If you dont pay it back, you are charged monthly interest.
But there are many factors, especially if you are in credit card debt, which makes it very important to understand how credit card interest.
For example, what if you only pay half the balance back? How is the interest calculated then? Or, what about new purchases? Do they accumulate interest right away?
Most people dont know that credit card companies actually charge interest on a daily, not monthly or yearly, basis. This compounds each day and you wont touch the principle until you pay down the interest. And there begins the debt cycle.
I want to explain how credit card interest works in Canada. My hope is that youll see that it can be extremely dangerous to your financial future.
How To Find Your Credit Card’s Apr
Your credit card’s APR is listed in your billing statement each month. You can also find this information in your online credit card account.
Keep in mind that credit cards can have multiple APRs, as the rate can change depending on promotional offers, penalties, and transaction types. Here are the most common types of credit card APRs:
- Cash advance
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When Is An Interest Rate Considered Low
Thereâs no industry standard for whatâs considered to be a low interest rate. However, the Federal Reserve determines the national average every quarter. For the fourth quarter of 2019, the average interest rate was 14.87%.
Your credit cardâs interest rate might be higher or lower than the national average, depending on things like your credit score and credit history. Just remember, the average credit card APR isnât necessarily what youâll get on a credit card youâre approved for.
Some cards offer a 0% introductory APR. This means that for a certain number of months you wonât pay any interest when you carry a balance. Just be sure to keep making your payments on time, and read through the terms and conditions to make sure you fully understand the offer.
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.
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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.
How Is The Minimum Monthly Payment On A Credit Card Calculated
Typically, the minimum payment is a percentage of your total current balance, plus any interest you owe. So if you owe $2,000, your minimum payment might be $40. There is usually a dollar amount for your minimum monthly payment also, so it may be expressed as something like, “$35 or 2% of your balance plus fees, whichever is greater.” Each credit card issuer calculates your minimum monthly payment differently. Consult your Discover statement and the terms of your account for information on how your Discover card minimum monthly payment is calculated.
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How Interest Is Calculated
Interest is always charged from the date of each transaction when you dont pay your current balance in full each month. This will be applied to transactions making up the current balance, and any new transactions, until the closing date of your next statement, taking into account any payments made to your credit card account. Therefore, if you pay your current balance in full in one month, but dont the next, youll be charged interest from the date of each transaction or fee on your current statement.
Heres an example:
Sarah sometimes pays off her credit card balance in full, and sometimes just makes the minimum payment required it depends on how her finances are looking that month.
She paid the balance shown on her 31 March credit card statement in full, so her opening balance on her next statement at 1 April is $0. On 9 April, she books a trip to Fiji for $700, and her closing balance at 30 April is $700. She plans to pay this balance in several payments over the next few months. Sarah will be charged interest from 9 April, the date she purchased her trip.
How Credit Card Interest Is Calculated
The average rate of interest on credit card debt is approximately 19%, with many as high as 29.99%.
Interest is usually shown as an annual percentage rate and is a fee paid for borrowing money so you can spend money today to purchase things you would normally have to save for.
But they also have made credit readily available and created a culture of buy now and pay later.
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Avoiding Interest On Cash Advances
Unlike regular purchases, interest will begin accruing immediately on cash advances.
This means you wont be able to avoid paying some amount of interest on a cash advance unless you pay it off the same day. If you have the money to pay it off right away, though, you probably dont need the cash advance in the first place.
Most credit cards will also charge you a fee when you use your card for a cash advance. Youll have to pay this cash advance fee on top of any interest fees the card issuer charges. A typical cash advance fee is 5% of the amount withdrawn, with a minimum fee of $10.
We generally recommend avoiding cash advances. Theyre an expensive way to borrow money. And while a cash advance by itself wont damage your credit, if it drives your credit utilization rate up higher, it might trigger a drop in your credit scores.
Now that youve read this guide, do you understand how you can avoid paying credit card interest? Please hit the Ask button on the top right corner of this page to ask any questions you have. Or, just get in touch to say hi and let us know what you think of this guide.
How To Save On Credit Card Interest
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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Why Is Residual Interest A Problem
Residual interest isnt necessarily an unfair practice its just how lending money works: If you pay a balance in full at the exact time your bill is issued, there wont be any residual interest. But most lenders give you a month or more to pay your bill after the statement date. The longer you wait, the more interest accrues that wasnt included on your last bill. That residual interest will come next month.
The problem with residual interest is the fact that most cardholders dont even know it exists or when it applies.
So now you know. If you have carried a credit card balance and are making one last payment, be on the lookout for an additional bill for residual interest.
Factor In Daily Compounding
Most credit card issuers will compound an account’s interest charges daily. That means it will actually multiply each day’s average daily balance by the account’s daily periodic rate, and then add that amount to the next day’s average daily balance.
To determine this manually would be extremely time-consuming. Thankfully, the effects of daily compounding are relatively minor over the course of a single month, so you’ll get a pretty good estimate from the amount you arrive at in step 4. However, the higher the interest rate, the greater the effect daily compounding will have on the final amount you’ll be charged in interest in a given month.
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Things You Need To Know About Credit Cards
There are some important points you need to keep in mind before applying for and using a credit card:
- The credit card provider will carry out a hard credit check when you apply. This will include checking your credit file. If youve got a good credit rating, this will improve your chances of a successful credit application. It could also give you access to cards offering the lowest interest rates and/or promotional offers. A hard credit check will show up on your credit report and will have the potential to affect your credit score.
- Some credit companies will perform a soft check before you apply. This type of credit inquiry will have no impact on your credit rating and will not show up on your credit report. It provides an indication of whether your credit application will be successful.
You can check your credit score for free by using the following websites:
Cash Advances Can Hurt Your Credit Score
When using a credit card cash advance, you are borrowing money from the bank or your card issuer .
The more ways you borrow money, the more vulnerable you could be to missing a payment and potentially hurting your credit score down the line. This may be particularly true for cash advances, which charge higher interest rate and therefore can make it more difficult to pay back what you owe on time.
Cash advances can also negatively impact your credit score by increasing how much money youâre borrowing relative to your overall credit limit, also known as your . Generally speaking, you only want to borrow 30% of your overall limit to get a good credit score, which may be a harder target to hit if you suddenly withdraw a large credit card cash advance.
Depending on the specific credit card you carry, you may even be required to undergo a separate credit approval process just to be considered eligible for a cash advance. Youâll want to dig into the details of your cardholder agreement or speak with a customer rep from your bank to clarify your cardâs policy beforehand.
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How Does Credit Score Affect Interest Rate
Your credit history, credit score and credit activity can affect the APR youâre offered. And a higher credit score potentially means better credit card options with lower interest rates. On the flip side, a low credit score may limit your choices. In that situation, lenders may offer you an entry card that has higher rates.
It can be helpful to understand what lenders take into consideration. Theyâll typically look at things like your payment history, how long youâve had accounts open and how much of your available credit youâre using. Whichever card you decide youâre interested in, itâs probably a good idea to try to improve your credit score.