Credit cards are tricky. Everyone knows how they work, but few people know how they really work. The basics are easy to understand. You're provided with a line of credit. You use your credit card on whatever you want to purchase. You have to make a minimum payment every month on the balance of your card.
Every credit card comes with an interest rate, meaning that you pay interest on the balance. The difficulty lies in figuring out how much your interest actually is, which is why figuring out your finances and creating a budget can be tough when you're using several credit cards. The following is a brief breakdown of how interest rates on credit cards work.
Understanding the Interest Rate on Your Credit Card
First of all, the interest charged on your purchases is different than the APR, which is what credit companies typically advertise. The reason they advertise the APR is that it's easier to understand. It's the annual percentage rate that you're paying. Even though it's advertised as an annual rate, credit companies use the interest that they charge you on a monthly basis in order to determine the APR.
Additionally, different credit cards have different types of APRs. It's either going to be fixed, which means that it always stays the same, or variable, which means that the APR changes along with the prime rate (which is published by the Wall Street Journal). Most variable rates begin with the current prime rate and add a margin. It's important to note that even if you have a card with a fixed rate, that rate can change based on certain conditions, such as if you're 60 days late on a payment. This is known as a penalty APR. The following are a few other APRs that you should be aware of:
· Introductory APR - Introductory APRs often seem like an incredible deal because of how low they are (in some cases, introductory APRs are even 0 percent). But they are only promotional, which means that they are temporary. Once the promotional period expires, the APR will increase.
· Purchase APR - This is the interest rate that's applied to any purchases you make using the card.
· Balance transfer APR - If you transfer a balance from one credit card to another, you'll often be charged a balance transfer APR.
Calculating How Much Interest You're Being Charged
To figure out exactly how much interest you'll end up paying, you'll need to figure out what your average daily balance is, how many days are in the billing cycle, and your credit card's APR. To calculate the amount of interest you're being charged, use the following steps: (numbers are approximate)
- Divide your APR by the number of days in the year.
0.1599 / 365 = a 0.00044 daily periodic rate
- Multiply the daily periodic rate by your average daily balance.
0.00044 x $1,500 = $0.66
- Multiply this number by the number of days (30) in your billing cycle.
$0.66 x 30 = $19.80 interest charged for this billing cycle
The math requires a bit of work, but the concept is simple: Carry a balance, and you’ll pay interest.
Feel free to check out this convenient credit card interest calculator for a quick look at what your credit card interest is really costing you.
Understanding how interest rates work can help you to better control your credit card usage. Additionally, by knowing exactly how to calculate interest rates, you'll have a better idea of how to create and maintain a budget as well as how to use your credit card more responsibly. For more information on how credit cards work or for a more in-depth conversation about getting your personal finances in order, contact us at Safe Money Partners today.