Being charged a fee for borrowing money may be a deterrent for some, however there has been a significant rise in credit card borrowing in the midst of the cost of living crisis. Having a clearer understanding of how credit card interest works will allow you to make a more informed decision and use this knowledge to your advantage whilst improving your overall financial health, below we’ll take a dive into what credit card interest is, how it works, and how being charged interest can be avoided entirely.
What is credit card interest?
Credit card interest is essentially the fee you are charged for using your credit to make purchases at the end of your credit card’s monthly billing cycle. This is usually shown as a yearly rate which is your APR and you are typically charged for this every month. Fixed and variable interest rates are the two major categories;
Fixed rates are pretty self-explanatory, for the period you are borrowing money your interest rate will stay fixed on an agreement. You will be notified in advance by your card issuer if there are any changes to this rate and any increase in interest you are charged will only be applied after you’ve been informed of the changes.
These rates differ from fixed in that they can fluctuate, having a variable interest rate could potentially mean a greater risk to cardholders as the rate of interest can be dependent on external factors such as inflation.
How does credit card interest work?
Card issuers calculate interest rates based on what your card balance is daily. You can calculate your interest rate with credit calculators available online or also by dividing your APR by 365 and then multiplying it by your current balance. However, this can sometimes be dependent on what the balance has been used for and different issuers will have different interest rates for this reason so it’s important to keep this in mind when evaluating if using a credit card is the best option for your financial goals.
Most card issuers offer a grace period from when your statement is issued to when you have been charged for interest on your credit. This isn’t the case for all issuers, however, grace periods can be a saving grace when it comes to avoiding accruing interest on your balance as they give you an interest-free period on your purchases. If your issuer does not offer a grace period it may make sense to look elsewhere for a credit card issuer if you want to focus on budgeting and staying on top of your monthly charges.
When using your credit card you must know how much interest you are accruing each month. Making sure your bill is paid in full and on time is the most effective way to make sure you aren’t going to be charged interest and also helps to build up your credit. Having a balance is not necessarily needed to build up your credit and you can do so without having to ever pay interest.
Lowering your interest rates
Interest rates can also be lowered if you have a positive and consistent repayment history as your card issuer may consider this if you decide to reach out to have your credit lowered. In the case where you have already accrued a balance, you can start reducing any increased credit by making multiple repayments within a billing period to lower your APR. Sticking to a budgeting plan will allow you to make smaller payments which will be easier to manage compared to a larger lump sum payment of your daily accrued interest.
In conclusion, credit cards can be a great way to borrow money for spending whilst also building up your credit score, but to avoid falling into debt with your card issuer it’s important to be aware of the type of interest you will be paying on your credit card if your issuer offers a grace period so you can effectively come up with a plan to budget your spending and manage any balance that has accrued within your billing period, once you’re clued up on the basics you’ll be able to use your credit card to your advantage and support any long term financial goals.