Understanding Credit Card Interest Rates.

Understanding Credit Card Interest Rates

It’s no secret – most of us have at least one credit card in our wallet. Despite the important role credit cards play in everyday life, if you are anything like the typical cardholder you may find these problems familiar: you are not sure about what the current interest rates are for your credit cards, you are unclear about how much principal versus interest you owe, and you are vague about other important account details that could save you money. To help you better manage credit card usage, and potentially keep your credit card debt under control, here is an insider’s guide to everything you wanted to know about credit card interest rates.

What Is Credit Card Interest?

Simply put, credit card interest is a fee you pay when you borrow money while making purchases. Some important points of clarification:

APR (Annual Percentage Rate) is the most common terminology used to describe credit card interest.
A more detailed view shows that there are several types of APR, in addition to other fees and expenses, which can be linked to your credit card. We will explore these in more detail below.
Finally, card issuers make most of their money from credit card interest. See tips below on how smart credit card habits can reduce your interest payments.

How Credit Card Interest Rates Work

Getting smart about how credit interest rates are calculated is the first step toward learning how to better manage your card usage and, ultimately, saving some money.

Although the APR is expressed as a yearly rate, the actual interest calculations are based on a daily rate, which is your annual interest rate divided by 365.

For example, you may have a credit card that features an APR of 18% annually, which works out to a daily rate of 0.049% (18% divided by 365). Now, if you made a $300 card purchase on the first day of the month, you would receive a $0.15 interest charge, resulting in a total balance of $300.15 the next day. Since interest charges are assessed daily, if you made no other card purchases over the next 30 days you would end up with a balance of $304.50, including principal ($300) and interest charges ($4.50), for the month.

Some people may feel that an 18% interest rate is not such a big deal – what’s so bad about 15 cents per day interest charge on a $300 purchase? However, if you step back and consider that the yearly interest charge on the typical US credit card balance of $4,000 – calculated at 18% APR – results in annual interest payments of around $720, you may begin to realize how interest charges affect your wallet.

Before we get into a discussion about how to reduce your exposure these kinds of APR interest payments, let’s review the full scope of interest rates that you may incur with an individual credit card.

One Card – A Variety of Credit Card Interest Rates

Believe it or not, there are up to six different APR interest rates that may be attached to your credit cards, depending on how you use them. Most of these different rates are linked to the great financial options provided by your card. Read on for the fine print.

Purchase APR – This is the APR that is applied to your monthly credit card purchases and is the interest rate we tend to think of when comparing credit card rates or considering the value of a new card. Your purchase APR varies based on the type of card you have.
Balance Transfer APR – This is the APR you will be charged for money you move or transfer from an old credit card account to a new credit card account.
Cash Advance APR – This is the APR applied if you use your credit card to access cash from an ATM, or possibly by cashing a check associated with the account.
Introductory APR – This is a promotional APR that is offered to entice consumers to sign up with a new card. It can apply to both purchases and balance transfers for a limited period of time (6-12 months), and is typically much lower than conventional interest rates.
Penalty APR – This is the highest type of interest rate you will find. The Penalty APR is typically triggered when you are 60+ days late with a payment.

In addition to this variety of interest rates, you should also be aware of various fees that may be triggered when you use your card.

Annual Fees – For many cards there is no annual fee. But for others that include various types of perks (including travel, dining, and business spending rewards) you may pay for the privilege – anywhere from $30 per year to as much as $500 or more.
Balance Transfer Fees – This is a one-time fee incurred when you have transferred debt from one credit card to another – usually a flat fee, or a small percentage of the money transferred – for example 3% of the amount transferred. This fee is separate from the APR interest incurred for transfers.
Cash Advance Fees – This is a one-time fee incurred when you use your credit card to borrow cash, typically by withdrawing it from an ATM. This fee is often a flat fee or a percentage of the amount borrowed – for example, 5% of the withdrawal amount. This fee is separate from the APR interest incurred for cash advances.
Foreign Transaction Fees – If you are an international traveler, you are familiar with this fee. When traveling overseas, many credit cards will charge a service fee for all credit card transactions – typically 3% of the purchase price.
Late Payment Fees – Most financial institutions will post this fee to your account if you fail to make the minimum monthly payment by the due date. The Credit CARD Act of 2009 caps the fees that issuers are allowed to charge for late payments – up to $27 for the first late payment and up to $38 for additional late payments.
Over-The-Limit Fees – If you make a purchase that pushes your account over the formal credit limit, your credit card issuer may charge this fee. By law, it can’t exceed the amount you are over your limit. A note of caution: in addition to incurring fees, going over your credit limit can negatively impact your credit score.
Returned Payment Fees – This fee is typically charged if you have insufficient funds in the account used to pay your monthly bill. Returned payment fees can range as high as $35 per occurrence.

The Good News about Saving Money on Your Credit Cards

Now that you understand some of the financial details of credit cards, it’s important to understand the tremendous financial benefits credit cards can offer during your everyday life.

Think of these classic credit card moments –you need to rent a car, you need to establish or grow your credit rating, you want more airline miles or cash rewards, you need to cover an unexpectedly large expense, your car breaks down and need to pay for an immediate tow. The benefits of having a credit card go on and on.

But financial experts also point out that credit cards should be used with care and a good dose of self-discipline. Specifically, it is important to manage the level of debt you carry on your card so that interest charges don’t become a financial drag.

Check out this quick summary of techniques to use your credit cards like a pro, save money on your cards, and keep your interest payments under control.

Pay your entire bill – Experts agree that the best way to manage credit card debt is simply this – pay off your card balance every month and avoid interest charges altogether. Credit card issuers offer a “grace period”, typically 21 days, when you are not charged interest for purchases on your monthly bill. Take advantage!
Pay more than the minimum – Credit card Issuers offer you the option to pay a low, minimum amount each month on your card – typically a small percentage (3% or less) of the total due. While paying the minimum may be enticing if you are financially struggling, paying more than the minimum amount due will seriously improve your financial position by reducing the amount of time and money it takes to pay off your debt.
Lower your APR – Most Americans have multiple credit cards, some with a higher-than-average APR. Consolidating your credit card debt into fewer cards with lower APR can reduce the overall interest rate you have to pay each month.
Reduce your overall debt – Most of us have racked up unwanted credit card debt at some point in life, resulting in larger interest payments each month. A focused campaign to pay off your credit card debt is the best way to fix this problem. Financial experts recommend the following approach – consolidate your debt load onto lower interest credit cards (or other loan instruments) and then ramp up the amount you pay each month. It’s not easy, but well worth the effort. And don’t forget to use a credit card interest calculator to figure out the monthly payments that will get you to the goal.

If you’d like to speak with an expert at Patriot Bank in CT and NY about building or managing your credit, please contact us.