iQuanti: Wondering how credit card interest works? Interest is essentially the cost of borrowing money.
Credit cards let you borrow money flexibly and pay it back later. However, for most credit cards, your issuer will charge you interest if you don't pay off your entire balance by a specific due date.
Beyond that, some cards have multiple interest rates, which can be confusing.
The below article will help dispel some confusion by explaining the basics of credit card interest.
How Credit Card Interest Works
Credit card interest is expressed as an Annual Percentage Rate (APR). The lender divides the APR by 365 to get a daily interest rate.
For instance, if your APR is 16%, your daily rate would be 0.044%. Your lender multiplies this by your balance each day for the entire billing period to calculate your interest amount. So if your balance was $1,000 on the first day, you'd be charged $0.44. The next day, they'd multiply 0.044% by $1,000.44 and add it to the balance to get $1,000.88.
Now, your lender adds this interest to your balance. This is called capitalizing the interest.
However, they won't actually add interest every day. This is simply how they calculate it. They'll capitalize the interest once the due date is past and you still have a balance.
Variable vs. Fixed APR
Variable APRs fluctuate with the prime rate — a universal factor that influences financial institutions across the board. The Federal Reserve sets the prime rate, and banks set APRs and APYs in response.
Fixed APRs don't fluctuate at all. Once you get your card, it stays at that APR.
Most cards are variable nowadays, although some fixed-APR cards exist.
Types of APRs
Credit cards can accrue balances from multiple sources, such as purchases, balance transfers, and cash advances.
Most card issuers charge different APRs depending on where that balance came from. You can find all APR information in your card's terms and conditions.
Here are some of the main kinds of APRs:
Purchase APR
This is the regular APR you're charged for credit card purchases.
Balance Transfer APR
If you transfer a balance from another credit card, you'll be charged this APR on that balance.
Cash Advance APR
If you take out a cash advance, you'll be subject to a cash advance APR. These tend to be significantly higher than purchase APRs.
Introductory APR
Many cards offer low or 0% introductory APRs for purchases and/or balance transfers to encourage new card applicants. These APRs usually last 12-18 months, after which they revert to their regular APRs.
Penalty APR
If you're late on or miss a payment, card companies will impose a higher penalty APR. You may also lose any 0% introductory APRs you currently have and suffer credit damage.
However, the CARD Act of 2009 legally requires issuers to reinstate your regular APR if you make on-time payments for six months straight after getting the penalty APR.
Credit Card Interest Explained
At the end of the day, credit card interest is the cost of borrowing from your lender. There are many types, and it can be fixed or variable.
But ideally, you never pay interest in the first place by paying your full statement balance each month. By doing so, you'll avoid wasting money on interest and worrying about all the details surrounding your interest rate.
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Original Source: Everything You Need to Know About Credit Card Interest
