Did you recently get a credit card, or are you considering applying for one? It’s a big decision and there’s a lot to consider. You’re probably even wondering, “how does credit card interest work?” Well, you’re not alone.
Credit cards come with a lot of perks, like allowing you to make big purchases even when you don’t have cash available and offering rewards for spending money. But there’s a catch: since you’re borrowing money, any unpaid balance on your credit card at the end of the month is subject to credit card interest.
Sometimes, having credit card interest is unavoidable, like if a financial emergency arises and you don’t have other options to pay. Other times, bad spending habits get slowly out of control and what was once a small interest charge and low unpaid balance has transformed into a mountain of debt that’s tough to overcome.
Paying off your balance is the best way to avoid paying interest, but since that can be easier said than done, we’ve got you covered with this report on how credit card interest works. In this article we’ll define what credit card interest is, how it’s calculated, and how you can lower your interest rate. Read on to learn more.
What Is Credit Card Interest?
Credit card interest is the amount of interest you’re charged on an unpaid monthly balance. The longer it takes you to pay off your balance, the more interest you’ll be charged. If you pay your credit card balance in full each month, you will not be charged any credit card interest.
Traditionally, credit card interest is expressed in your annual percentage rate (APR). The APR on any given credit card account tells you how much interest you will be charged annually for borrowing money.
Credit card interest is extremely commonplace. In 2018, Americans paid $113 billion in credit card interest, up 12 percent from the interest paid in 2017. These statistics put credit card rates at a record high and they’re rising the fastest for people with low credit scores.
How Is Credit Card Interest Calculated?
Credit card interest is usually calculated daily, so while it’s important to pay attention to your APR, it’s not the most accurate way to determine your current interest rate.
The daily periodic rate is the rate you will pay per day on interest. To calculate this, divide your APR by 365 (days in a year). That amount will tell you how much interest you’ll be charged daily on any unpaid balances. When doing this calculation on your own, keep in mind that your APR and interest rates can change, so you’ll always want to look on your account and use your most current APR.
If your APR is 20 percent, divide 20 percent by 365 and you will get your daily periodic rate, which is .54 percent.
Now let’s say you have a $500 balance on this card and you only plan to make the minimum $10 payment on this transaction every month. Even if you don’t accrue any more charges, it will take you 8.3 years, or 99 months, to pay off this charge and you will pay $498.54 dollars in interest!
Is the Interest on a Credit Card Monthly?
Your credit card issuer will only charge interest on purchases if you carry a balance from one month to the next. Each month you don’t have your balance paid off in full, you will be charged interest.
If you don’t carry a balance over from month to month, you will not be charged credit card interest at all.
Fixed vs. Variable Credit Card Interest Rates
Before you sign up for a credit card, it’s important to understand the difference between a fixed and variable credit card as that will determine how often your interest rate changes.
For example, a variable APR credit card means that your monthly or quarterly APR can change based on index rate and one example is the prime rate.
Conversely, a fixed APR credit card means your APR will not change when the index rate fluctuates. This rate can still change based on your credit report history, but typically your credit bureau will have to issue a 45 day warning before any changes occur.
How Do I Lower My Credit Card’s Interest Rate?
Sometimes it can feel like you have no control over your debt, but there are steps you can take to try to lower your interest rate. Even better, lowering your interest rate may allow you to pay down your balance faster.
The best chance you have at getting a lower interest rate is having a good credit score. Having a good credit score gives you access to better credit card options. It also tells creditors you are less of a risk so they are more inclined to offer you a lower APR.
If you have a good credit score, you can call and ask your credit card company to consider lowering your APR. You can still try to negotiate a lower APR even if your credit score is lower than the average, but this may result in a hard credit pull.
Credit card companies don’t want to lose you as an account holder so talking to them about your options can work in your favor. Just make sure to do your research before you negotiate in order to get the best possible results. Learn about more ways to lower your interest rate here.
6 Ways to Avoid Credit Card Interest
Credit card interest can get really pricey and make it much more challenging to get out of debt. If spending is not kept under control, minimum monthly interest payments can become greater costs than you are able to pay and you will ultimately spend much more money on purchases than you borrowed in the first place.
The best scenario if you hold a credit card is to make it so you’re never charged any interest. Here are six ways to avoid or reduce credit card interest:
- Pay off your card every month: The most simple way to avoid interest is to never accrue debt. Don’t spend money you don’t have and set payment reminders for yourself so you never make a late payment.
- Pay your bill the day it becomes available: Interest gets assessed daily, so if you want to pay as little interest as possible, pay your credit card statement the day it becomes available rather than waiting until the end of the billing cycle.
- Sign up for a card with a 0% introductory APR: If you’re just establishing credit or looking to open a new credit line, look for cards that offer a 0% introductory APR. You won’t pay any interest during the introductory period, so if you need to make a purchase that you know you can pay off in a limited amount of time, this option allows you to pay 0 interest on that borrowed balance.
- Ask for a lower credit limit: If you know that you are susceptible to temptation, ask your credit lender to keep your credit limit at a level you can always afford to pay off. For example, asking for a $1,000 credit card limit will keep you from spending over $1,000 each month. This option could impact your utilization ratio, which may negatively impact on your credit score.
- Switch to a 0% card: A balance transfer allows you to switch your balance over to a different card and sometimes, you can qualify for a 0% introductory APR card that will allow you to pay off your balance with no interest for a limited amount of time. Keep in mind there is a charge to make a balance transfer.
- Consider joining a credit union: If you are eligible to join a credit union, you may be able to save big on interest rates. Credit unions traditionally offer lower rates and loans. Learn more about joining a credit union.
Mastering Your Credit
Getting charged credit card interest can be very costly. While avoiding a credit card balance altogether is the best way to avoid credit card interest, sometimes debt is unavoidable. Understanding how your interest score is calculated will allow you to make smarter decisions around your credit health. Using the six tips above can help you avoid or reduce your credit card interest, too!
Turbo is here to help you on your financial journey every step of the way. Discover more ways to be smart with your credit card here.