Credit card interest is the percentage you pay a lender for the use of the credit card. Credit card interest fees are typically in the form of an annual percentage rate (APR).
The APR is the total yearly cost of borrowing against your credit limit. While loans can have fixed or variable rates, most credit card interest rates are variable. A variable interest rate changes periodically depending on an index rate. You can read your card’s terms and conditions to better understand how the APR works.
When a consumer submits a credit card application, the issuer will review their credit history. Credit card issuers typically offer lower rates to borrowers with high credit scores because they are considered less of a risk . Suppose a creditor is not confident a borrower can reliably make monthly payments on time. In that case, they will offer higher interest rates.
How Credit Card Interest Works
Knowing how credit card interest works is critical before you start using a credit card.
The amount you will end up paying for carrying a revolving balance month to month may change your spending habits. When a borrower uses their credit card, the credit card issuer will send a monthly statement at the end of the billing cycle. The borrower must pay interest on purchases if the credit card bill is not paid in full. But you do not have to pay for using your credit card if you pay your current balance every month!
Average Daily Balance
Most companies charge interest according to the average daily balance method. The average daily balance on a credit card is the balance at the end of each day divided by the number of days in a billing cycle. Most billing cycles last 28 to 31 days.
The daily balance of your credit card consists of the following:
- The credit card balance at the start of the day
- New charges from today
- Today’s payments and statement credits
- Today’s fees from transactions
To calculate your average daily balance, you need to know the number of days in your billing cycle and the sum of the daily balances over your billing cycle. Let’s say that your billing cycle is 28 days. Your daily balance on a credit card is $150 for 10 days, $300 for 10days, and $550 for eight days.
Multiply the daily balance by the number of days they remained fixed to get $1,500, $3,000, and $4,400. The total of your daily balances comes to $8,900. Now that you know your total daily balance, you can divide $8,900 by 28 days to calculate your average daily balance. According to this information, your average daily balance is $317.86.
Compound Interest
In addition to using the daily balance, a credit card issuer may also charge compound interest. Financial institutions calculate interest using simple interest or compound interest, depending on the type of loan you get.
- Simple Interest: Calculates interest on the principal balance of the loan.
- Compound Interest: Calculates interest on the principal amount and accumulated interest of past periods.
Suppose the credit card company calculates interest using the average daily balance method and compounding interest. In that case, your interest fees may increase quickly.
Compound interest forces you to pay additional interest fees based on existing interest fees. Due to compounding interest, many people struggle to keep up with their credit card debt. But you can stay on top of your budget by meeting billing cycle payment deadlines.
What Are the Different Types of Credit Card Interest?
There are different types of interest rates on a credit card. The interest rate you pay depends on the transaction you make and your payment history. Knowing the different kinds of APR you may have to pay with a credit card can help you make better spending decisions and save money on interest fees!
- Purchase APR: The purchase APR is the standard interest rate you must pay for everyday purchases.
- Penalty APR: Borrowers are subject to a penalty APR when a payment gets returned, or a monthly payment is more than 60 days late. The penalty APR is higher than the purchase APR and can last at least six months! If you make timely payments for six months, the credit card issuer can revert the APR back to the regular APR.
- Cash Advance APR: You will have to pay a cash advance APR when you use your credit card or credit card checks to withdraw cash at an ATM, bank, or credit union location. A cash advance APR applies immediately with no grace period and is the highest rate on a credit card.
- Balance Transfer APR: A balance transfer APR is the cost you pay to transfer credit card debt to a new card. Some creditors provide a 0% introductory balance transfer APR for new borrowers. However, the promotional rate will eventually revert to a standard rate within a few months or years.
If you ever forget what your annual percentage rates are for different credit card services, don’t worry. You can find your credit card APR on the monthly statement or on the copy of your agreement. If you lost your credit card agreement, you can request a new one or view it through your online account.
Can a Credit Card’s Interest Rate Increase?
When you open a credit card account, your interest rate will depend primarily on your credit history. Suppose you have a good credit rating and secure a decent interest rate. Unfortunately, that rate can increase over time due to rising prime rates and other factors.
For example, almost every credit card company charges variable interest rates. Variable rates change every now and then due to an index rate. However, your interest rate can also increase due to one of the following reasons:
Missed Payments
Missing credit card payments result in late fees and additional penalties. Your credit card’s APR can increase if you constantly miss monthly payments. The credit card company may issue a penalty APR when a monthly payment returns or is more than 60 days late. A penalty APR is higher than the standard purchase APR and can last at least six months.
High Credit Card Balances
Maintaining a high credit card balance can increase your APR! Have a lot of credit card debt? Your creditor may determine that you are a credit risk and issue a higher purchase APR to offset the lending risk.
End of a Promotional Period
Many credit card companies offer promotional interest rates to attract new applicants. Suppose you applied for a new card and got a 0% intro APR. In that case, your interest rate will increase once the promotional period is over. The amount of time you have to make interest-free payments depends on the credit card company you work with. However, promotional rates typically last from 12 to 18 months.
Credit Card Cash Advances
A credit card cash advance is when a cardholder borrows cash against their credit limit. Borrowers can take out a credit card cash advance at an ATM, bank, or credit union. While convenient, credit card cash advances are pricey due to the high APRs. This type of rate is always higher than the purchase APR you pay on everyday purchases.
When you first open a credit account, you may not see an interest rate increase for at least a year. Generally, credit card companies cannot increase rates during the first year of account opening. When a credit card company does increase a borrower’s rate, they must provide borrowers with a 45-day advanced notice.
How To Get a Lower APR on a Credit Card?
There are many credit card companies to choose from when you want to open a revolving credit account. And while there are a lot of factors to consider when narrowing down your options, the APR is the most important. High APRs will make repaying the credit card more difficult because they increase the current balance if you don’t pay off your card in full monthly.
If you want to get a low APR, follow these methods:
Look for Promotional Rates
If you want a new credit card, look for creditors that offer 0% introductory APR offers. These offers are great for borrowers needing help paying off existing credit card debt. Balance transfers are when borrowers move credit card debt from one account to another.
Moving debt to an account with no interest fees can save you money while you pay off the debt! But inquire about the length of a promotional period because they can last a few months up to a couple of years. In addition, ask about the balance transfer fee. If the balance transfer fee is high, you may end up paying a lot to transfer your credit card debt.
Switch Credit Cards
Many credit card borrowers use reward credit cards to accumulate points, cash back, or travel miles. These cards allow borrowers to earn rewards for spending at specific locations, such as restaurants or gas stations. However, rewards cards typically have higher interest rates than standard credit cards. Even if you have an excellent credit score, your rate may still be high with a reward credit card. If you have trouble managing your spending habits, it may be better to switch to a standard card in order to get a lower rate.
Negotiate With Your Creditor
If you have a high-interest rate on your current credit card, you may feel like you have to switch companies to get a lower rate. While you may be able to secure a lower rate with a new creditor, you can also try negotiating with your current creditor.
Call the customer service line and ask if you can get a lower rate. An agent will pull up your account information and make a decision based on your payment history, account opening date, and more. You stand a good chance of getting a lower rate if you continuously make on-time payments and maintain a low balance. The worst they can say is no, so try negotiating today.
How To Choose a Credit Card?
If you’re interested in applying for a revolving credit account, you may wonder how to choose a credit card. There are numerous credit cards to choose from, so what type should you get, and what details should you pay attention to?
There are seven main types of credit cards to choose from:
- Retail Cards: A retail card, or store card, is a branded card that stores offer. If the retail card is an open-loop card, then you may use the card anywhere that credit cards are allowed. On the other hand, closed-loop cards may only be spent at specific stores.
- Rewards Cards: A reward credit card can help borrowers accumulate points, cash back, or travel miles. While you may be able to get rewards for everyday purchases, you will accumulate more by spending money on specific activities, such as dining or getting gas.
- Standard Cards: A standard credit card allows you to spend money anywhere credit cards are accepted. These cards are known as “no-frills credit cards” because they do not offer special rewards or benefits.
- Secured Cards: A secured credit card can help people build credit over time. To qualify for a secured card, you must provide a security deposit. The deposit is equal to the amount you can spend. Continuously making timely payments can help you build a strong credit score over time.
- Business Cards: Business owners can get unique credit cards to buy business expenses. Business credit cards are ideal for keeping business and personal transactions separate.
- Student Cards: A student credit card is meant for college students to use for school-related or personal expenses. Creditors know students may not yet have a credit history, so the qualification requirements can be minimal.
- Subprime Cards: A subprime card is for borrowers with bad credit scores. While the approval rate is generally high, these cards tend to have high-interest rates and fees.
Once you know the type of credit card you want to get, it’s essential to ask about the loan terms. For example, ask about the interest rates, fees, minimum and maximum credit limits, and days in a billing cycle. The answers to these questions can help you pick the best credit card for your spending habits.
How Much Credit Card Debt Is Too Much?
Many credit card borrowers carry a balance month to month. But how much credit card debt is too much? Unfortunately, there is no baseline answer because the maximum amount of debt a person should have depends on their income and monthly expenses.
However, even if you cannot repay your credit card every month, carrying too much debt can hurt your credit score. Credit card debt makes up 30% of your FICO score. If you max out credit cards, you can end up decreasing your score despite having an excellent payment history.
A great way to tell if you have too much debt is to check your credit utilization ratio. Credit utilization is the difference between how much available credit a consumer has compared to their credit limits. Financial experts often advise consumers to avoid using more than 30% of their total credit limit to avoid negatively affecting their credit.
To calculate your utilization ratio, follow these four steps:
- Add up all of your current credit card balances.
- Add up all of your credit card limits.
- Divide your total credit card balance by your total credit limit.
- Multiply your answer from Step three by 100.
The answer from Step four is your credit utilization ratio as a percentage!
How to Quickly Pay off Credit Card Balances
The best way to save money with credit cards is to pay off your balance before the end of your billing cycle. But what methods can you use to quickly pay off existing debt? Learn about four different payment options below.
Avalanche Method
The avalanche method is a debt repayment strategy that helps you save money on interest fees. Borrowers focus on paying down the card with the highest interest rate first. Pay as much as you can toward that debt and pay the minimum on all other debts. This repayment method can help you save a lot of money.
Snowball Method
The snowball method is similar to the avalanche method, but borrowers first focus on the smallest debt amount. Start by paying as much as you can spare toward the smallest credit card balance and paying the minimum on every other debt. This debt repayment method can keep you motivated, as you can quickly pay off multiple debts.
Debt Consolidation Loan
Consolidating your debt can help you save money on interest charges. Debt consolidation is when you merge various debts into one account to get fewer monthly payments and interest fees. Many consumers use installment loans, such as personal loans, to pay off high-interest credit cards.
Balance Transfer Credit Card
A balance transfer credit card is a card that helps borrowers pay off existing credit card debt. You can transfer all your credit card debt to one account with a lower interest rate. Many credit card issuers offer 0% APR offers to new applicants. You can end up paying zero interest fees if you pay off the debt before the end of the promotional period. However, ensure you ask about balance transfer fees because they vary by lender.
When can my credit card company increase my interest rate?│Consumer Financial Protection Bureau