How Does Your Credit Card Interest Work?

Interest Rate

Credit card is subjected to an interest rate called the Annual Percentage Rate (APR). This interest number varies from card to card and person to person depending on many factors such as credit scores. Your annual percentage rate is expressed in terms of a year, but credit card issuer use it to calculate charges over your monthly statement. So just like kilometer/hour is a way of measuring speed over an hour, annual percentage rate measures interest over the given time period of a year. But in both cases, the calculation can still be used for longer or shorter time periods.

How To Calculate Interest Rate?

The interest rate you’re paying on your outstanding every day, can be calculated by converting your APR to a daily percentage rate. You can do so by dividing your annual percentage rate by 365 i.e. the number of days in a year. At the end of each day, the credit card company will multiply your outstanding balance by the daily rate to come up with the daily interest charge. These charges are added up in a process called compounding.

For example:

Assume that you credit card have an annual percentage rate of 20%, then it will have a daily rate of .054794%. Assume that cardholder has an outstanding balance of $1,000 at the 20% annual percentage rate APR standard interest rate. Next day, interest amount is added and the outstanding balance becomes $1,000.41, plus any extra purchases and minus any payments. This cycle continues each day until the end of the cardholder’s monthly statement cycle.

Different Types Of Interest And Annual Percentage Rate

There are some other details about your credit card that you should review to know how much you could pay in fees if you’re not careful. Below are some points that you need to know before signing up for a credit card.

Your credit card can either have a fixed Annual Percentage Rate (APR) or a variable APR. A fixed APR remains the same, but it can change in some circumstances, like if your payment of outstanding amount is more than 60 days late or when an introductory offer expires. A variable rate usually changes with the prime rate, as mentioned in the Wall Street Journal. Most of the variable interest rates start with the prime rate, then add a margin. The result you get is your variable APR.

Credit cards generally have many different types of APR like:

• Purchase Annual rate: The interest rate that is applied to purchases which are made with the card.
• Balance transfer Annual rate: The interest rate that is applied on the balance transferred from one credit card to another.
• Cash advance Annual rate: The interest rate that is applied to the amount of cash borrowed from your credit card. This interest rate is generally higher and does not have a grace period. As the Consumer Financial Protection Bureau notes: “If you use your credit card to get a cash advance, you will start paying interest as of the date of the transaction.”
• Introductory Annual rate: The temporary promotional rate that few credit card companies offer to get you to sign up. This applies to purchases and/or balance outstanding transfers for a limited time period, and is generally lower than the card’s regular APR — sometimes 1-2 or 0 percent.
• Penalty APR: This is the interest charged when you make late payments or violate the credit card’s terms and conditions. This is generally the highest rate, and it may be levied when your payment for balance outstanding is more than 60 days late.

The purchase annual rate is used to calculate how much interest you will pay on an outstanding purchase balance. If you have excellent credit score (generally scores of 750 or higher), you are 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 score (generally scores between 550 and 699), you may get comparatively higher interest rate if you are approved for the card. This means it’ll cost you more interest amount every time you carry a balance with your card, so be sure to pay off your outstanding balance on time and in full every month.

The Bottom Line

It is important that you are aware of the various interest rates before you register for any credit card. Not only this, you should know if the interest rates are fixed or variable. You should be able to understand all the factors that can make your credit card company to change it.

It is to be noted that introductory offer annual rate periods don’t last for a lifetime. In addition to this, if you pay your balance more than 60 days late, you will have to face a penalty APR. What this essentially means is that you will be charged higher interest for several months or maybe even longer.

It is, therefore, advised that one should make the payments in due time. In addition to this, it is also to be noted that one should make full payments and not only the minimum payment required by the credit card company. This will help you save money that you will otherwise have to pay as interest in the future, and as they say, ‘Money saved is money earned!’

 

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