Getting your first credit card is an exciting milestone. When used responsibly, it offers a variety of benefits, from building credit history and making secure payments to accruing points with reward programs. But if you’re not careful, you could hurt your credit score and fall into debt, which can take a long time to pay off.
Before making the first transaction, it’s important to learn how credit card interest impacts your balance. Below is a comprehensive guide to credit card interest rates that will help you stay on the right path to building good credit.
How does credit card interest work?
Annual percentage rate (APR) refers to the credit card interest rate that is applied to your total balance. For instance, if you have a balance of $100 on your account and an APR of 13%, your balance would $113. You have a grace period – starting from the date your statement is issued up until the payment due date – in which you can pay off the full amount without incurring any interest.
How to calculate your interest rate
Interest is calculated on a daily basis. To determine your daily interest rate, divide your APR by 365 (the number of days in the year). For example, if you have an APR of 18%, your daily interest rate would be .00049.
To determine the amount of interest incurred for the billing cycle, the daily interest rate is multiplied by the average daily balance. The average daily balance is calculated by adding each day’s balance and dividing the sum by the number of days in the billing cycle.
If your average daily balance was $1,000, the .00049 interest rate would be multiplied by 1,000 to equal .49 per day. For a 21-day billing cycle, this would be $10.29 total interest. This interest is only applied if you don’t pay the balance in full by the end of the grace period.
If you allow your balance to incur interest charges, you will also be charged compounding interest. This means that if you have a balance of $1,000 plus $10.29 interest, you will be charged interest upon the full total of $1,010.29. While this might not seem like much in the beginning, it’s easy for compound interest to add up and make it more difficult for you to pay off your credit card.
Track your credit card interest
Knowing how to read your credit card statement will help you identify any errors and understand how much interest you’re being charged.
Current Balance: The total balance owed on your account, including interest.
Minimum Payment Due: The minimum amount you must pay to avoid late fees.
Account Summary: This section provides important details, such as the previous balance, new purchases and credit line availability.
Most credit cards have a variable APR, which means the rate can change over time. This is often calculated based on the prime rate. Look for the interest section on the statement to identify your current APR.
You’ll notice that there are various APR rates on your statement. You may pay a different APR for cash advances or balance transfers than you do for regular purchases.
Don’t let credit card interest get the best of you
So how do you avoid paying interest? The simplest way is to pay off your full balance within the grace period each month. However, if you find that you can’t cover the full balance, pay off as much as you can to reduce the amount of interest incurred.
Always pay the minimum balance due as late payments can negatively impact your credit score. Some issuers also subject cardholders to a penalty APR, a higher interest rate, if payments are not made on time.
Some credit cards feature an introductory APR of 0% for a limited period of time, often 12 months within opening the account. While this might seem like an incredible offer, it often means that the APR will skyrocket once the introductory period has ended. Always read the terms and conditions on the contract to understand how the interest rates can change. Be ready for the 0% intro period to end, and pay off your card.
If you find that you’re paying too much interest on your credit card, consider a balance transfer card. This is the process of moving your balance onto another credit card with a lower interest rate. While a balance transfer can make it easier to manage payments, read the terms and conditions to ensure that you take into account any fees involved.
If you’ve had your card for some time and never missed a payment, it’s also possible to request a lower rate from the credit card company. There’s no guarantee that your lender will agree, however, you can always close your credit card and open a new one with a lower interest rate.
In a nutshell
Now that you have a better understanding of how credit card interest rates work, get out there and start building your credit history. Always read the fine print on your credit card contract and make sure to be on time with your monthly payments, even if you can’t pay the balance in full.