Owning a credit card has become quite easy if you are working and have a good enough salary; it makes it easy for you to shop, afford fancy meals at elite restaurants, and whatnot. However, paying off your monthly credit card bill is quite important, or else you’ll be charged with a hefty interest on the borrowed amount. So, exactly how does interest on credit cards work?
As stated above credit card interest is the interest that is charged on your credit card if you don’t pay back the full amount of the bill. You might have paid half of it, but it won’t matter. And this applies to all credit card companies, no matter which one you go for.
Let’s go down a little deeper.
What is Credit Card Interest?
So, while we talked about how does interest in credit cards work, let’s get to know more about it. When you spend money with your credit card, you are basically borrowing money from the credit card company for which they charged an interest rate. This interest rate is known as the Annual Percentage Rate or APR.
Most of the credit cards have variable APRs which vacillate with an appropriate criterion like the prime rate. Hypothetically, if your prime rate is 4% and the interest on your credit card is 12%, your APR becomes 16%.
If you aren’t paying the full monthly balance of your credit card bill, you will be paying the credit card interest whenever you are paying your credit card bill.
Sometimes, the credit card interest gets out of hand in a short period and shoots up to the sky in a way that it becomes too hard to pay back.
So, having a strong knowledge of how interest on credit cards work will eventually save you from paying unnecessary interest on the money you have borrowed.
It has been seen that many credit cards have multiple interests rates which can complicate your credit card debt. So, having enough understating of credit card interest will help you in many ways.
How Does Interest On Credit Cards Work?
Let’s get a bit numerical when it comes to how credit cards interest work. When you are not able to pay off the monthly credit card balance in full, the credit card interest comes into the picture.
There is a particular way of calculation for credit card interest.
First of all, the daily rate of interest is calculated by diving your annual percentage rate (APR) by 365 (number of days in a year).
i.e. if your APR is 16%, then 16%/365 = 0.00044 is your daily rate of interest.
After that, your Average Daily Balance is calculated as your interest is estimated on it.
To do so, go to your unpaid balance from the previous statement period. Next up figure out what was your everyday balance.
Note: Generally, your credit card company won’t tell you your daily balances for the month; you’ll need to do it yourself by adding or subtracting individual charges for each date of the billing cycle as they appear on your statement.
Then sum up each daily balance amount and divide it by the number of days in your credit card’s billing period. The result will be your average daily balance.
Once you figured out your daily rate and average daily balance, multiply both.
Suppose, your average daily balance is $1000. The calculation would be 0.00044 * $1000 = $0.44
Now multiply the result with the number of days in your billing cycle (let it be 30days).
Then the calculation would be:- $0.44 * 30 days = $13.2
So, this means you’ll be charged $13.2 interest for this billing cycle.
So, if you carry a balance of $1000 at the start of your billing cycle, with the addition of interest, your balance will rise to $1013.2 at the end of the day. The next day you’ll be charged with $13.2 interest and your balance will be $1026.4. The process will continue till the end of your billing cycle. That’s how does interest on credit cards work.
Keep in mind that if you make any additional spending using your credit card during that billing period, that will also add to your total balance.
How Do Credit Card Companies Earn?
If we talk about credit card companies, they have two ways of earning money; first by the fee charged at restaurants, retail shops, and online shopping, second, by the credit card interest charged on you.
Now you know that how does interest in credit cards works, so, the best way to get away from credit card interest is by paying your monthly balance in full.
The other point to be noted is that the interest on most credit cards is variable and changes from time to time.
Apart from that, there are certain credit cards available that apply multiple interest rates on their card. Along with that, your credit score plays an important part in deciding the interest that would be applied to your credit card. This is how do credit cards work interest.
How to Avoid Credit Card Interest?
Now you have got an idea of how does interest on credit cards works, there are certain steps that you can take to avoid or decrease credit card interest. The first is pretty obvious; start paying your credit card monthly balance in full.
If you think that it is a really big amount to pay in full, cut back on your shopping list.
Apart from that, if you are not able to manage your bills, here’s a tip. While you know that how do interest rates on credit cards work, most credit card companies provide you with at least a 21 days grace period.
This grace period is between the date of your purchase and the due date of the payment.
If you make use of this period to pay off the monthly credit card balance in full and don’t have any outstanding cash advances as well, there won’t be any interest charged when you go shopping again.
Moreover, if you still can’t pay back the whole monthly balance in the grace period, at least pay a little more than the minimum. So you can avoid the late fee and decrease the total balance to be paid. Usually, the minimum payment is about 3% of the outstanding balance to be paid.
How to Choose The Write Credit Card?
However, not all credit cards companies provide the grace period offer. So, if you are still looking around to get a credit card, make sure you opt for a credit card that provides you with one.
There are certain details about your credit card that you might not even know. For instance, a credit card can either have a fixed APR or a variable APR. If your credit card’s APR is fixed, then it won’t change unless you haven’t paid back your balance amount for more than 60 days, or an offer has expired.
However, if your credit card has a variable APR, it often changes with the prime rate. There are numerous APRs that you should know about, such as Purchase APR, Balance Transfer APR, Cash Advance APR, Introductory APR, and Penalty APR.
Although you have understood that how does interest on credit cards work, you also need to understand how your credit card interest is determined. Not everyone is charged the same interest rate on their credit card. Well, it is based on your credit card application as well as your credit score. Basically, the higher the credit score you have, the lower will be your interest rate.
No matter from which credit card company you get your credit card, it is a great way to shop online, at stores, or dining. However, with great power comes great responsibilities. And that is to make sure you pay back your credit card monthly balance in full. It will make sure that no credit card interest is charged in the future.
Now that you have a clear idea about how does interest on credit cards work along with some additional information, you must stay alert. Make sure you pay back your credit card balance in time, and if not in full, at least a bit more than the minimum. If your credit card company offers you a 21 days grace period then make the most of it.