Credit card interest can be confusing to understand when so much of your money is being thrown around on a regular basis – not to mention some people have multiple cards with multiple rates.
While the option to move over to a debit card has proved enticing to some, many still recognize that credit cards offer tremendous value (not to mention credit card rewards) when wielded with steady hands.
The trick, as it is with many financial products, is to avoid getting hit by nasty interest charges … but first you must understand them.
How credit card interest is calculated
Calculated on a daily basis by your financial institution, credit card interest is determined with a simple formula:
The outstanding daily balance on purchases made, cash advances and special balances, plus any previously unpaid interest…
…Multiplied by the daily interest rate of your credit card (calculated by dividing the annual rate by 365).
The types of credit card interest explained
While the stock standard calculation of determining your credit card interest is fairly straightforward, you should be mindful of the different types of interest you can tally by using your credit card in a variety of ways.
These charges are for standard purchasing costs; such as when you go to the shops, get groceries, or when you pay a bill online. You can minimise these charges by opting to use a standard savings/transaction account card in lieu of a credit card for everyday transactions.
Interest on cash (cash advance)
This is the interest you’re charged on cash transactions. You can avoid this by not using your credit card to withdraw cash from ATMs or performing funds transfers.
These are interest fees charges on special transactions (e.g. promotional transaction deals, balance transfers to a different financial institution than your own).
Balance transfer interest
Like the name would imply, this is the interest you’re charged when you perform a balance transfer from one credit card provider to another. Any unpaid debt at the end of the special offer period typically reverts to the purchase interest rate. But check the details of the offer before signing up for the balance transfer.
Credit card interest free period
You should also be mindful that you can avoid interest pitfalls simply by paying off your credit card balance within the interest free period. This period varies from institution to institution, but is usually 44 or 55 days and gives you a chance to pay off your account in full before the bank charges any interest. That said, there is an exception, when you make a cash advance or a balance transfer the bank will begin charging you interest immediately.
Interest never goes away; it accumulates until you pay off the closing balance of your account. To avoid being hit by massive interest charges, don’t just pay of the minimum amount due every month: pay it off in full. For more credit card tips, read our article about credit card control tactics.
Article updated 19/07/2012