Editorial Policy

The 7 Commandments of Credit Card Interest

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By Eva Norlyk Smith, Ph.D.
September 27, 2011

High credit card interest charges can take a significant bite out of your hard-earned money. To protect yourself, follow these seven commandments of credit card interest:

1. Know your APRs.
Most people are familiar with a credit card’s purchase APR, which is the interest that accrues on purchases charged to the card. Most have also heard of promotional APRs, such as 0 APR offers on balance transfers or purchases.

However, there are several other members of the APR family, which you ignore at your own risk. These include:

Cash Advance APRs. A cash advance APR is the interest you pay on cash taken out at ATMs or banks using your credit card.
Overdraft Advance APRs. Overdraft advance APRs are charged by some card issuers on balances resulting from over-the-limit charges.
Penalty APRs. Penalty APRs are triggered if you pay late, miss a payment or fall behind on payments with other loans you have with the card issuing bank.

2. Pay attention to cash advance rates.
Each time you take out a cash advance, you pay a premium for the privilege of spending your hard-earned money. Not only will you pay a 3 percent cash advance fee, the APR on cash advances is higher than the purchase APR (often as high as 24.99 percent), and the interest begins to accrue from day one.

“Many people take out cash advances, because they need cash bad and they don’t bother to read the terms,” says Harrine Freeman, author of “How to Get Out of Debt: Get an ‘A’ Credit Rating for Free.” “It’s one of the reasons people get into credit card debt. If you can’t pay it off at the end of the month, the balance can increase really fast, because the cash advance interest is so high.”

3. Remember the WYSI(PN)WYG principle.
When applying for a credit card, remember the WYSI(PN)WYG principle: What you see is (probably not) what you get. For example, new card purchase APRs are often advertised as a range, such as “between 9.99 percent to 22.99 percent.”

“Interest rates usually have such a range that they really don’t tell you much about what interest rate you’re actually going to end up with,” says Josh Frank, a senior researcher at the Center for Responsible Lending. “It’s not really useful when people get told a range of rates varying by more than 10 percent. You want to know what the credit is going to cost, but there’s just no way of knowing that.”

Even those with excellent credit rates don’t know if they will get the very best purchase APR offered or a higher rate. And this lack of information can have big consequences.

For example, assuming a $5,000 credit card balance, the interest on a card with a 9.99 percent APR adds up to about $500 a year. However, on a card with a 22.99 percent APR, the total interest charged shoots up to a whopping $1,150 — more than twice as much.

4. Bear in mind that paying more pays more.
Paying just the minimum monthly payment every month is like taking two steps forward and one step back. The credit card balance gets reduced by the amount of your payment, but it also increases by the amount of credit card interest that has accumulated since your last payment.

And thanks to the Credit CARD Act of 2009, there’s another great reason to pay more than the minimum. The amount of the minimum payment gets applied to the balance with the lowest APR, and any amount paid above that gets applied to the balance with the highest interest rate, such as cash advance balances. This means that if you pay only the minimum month after month, balances with the highest interest rates will never get touched. Paying more pays more.

5. Memorize your penalty triggers.
Credit card issuers don’t just charge penalty fees if the credit card bill isn’t paid on time or if you go over the limit. Any of these actions may also trigger the penalty APR — a punitive interest rate that is typically around 29.99 percent. This rate will be applied to future charges on the card, and while card issuers are obliged to review the penalty rate every six months, it is their choice whether they lower it and by how much.

Penalty rate triggers — and how strictly they are enforced — vary from card issuer to card issuer. If you’re not sure what they are for your card, call your card issuer to ask.

6. Heed the grace period.
The typical grace period is between 20 and 30 days, so that is a fairly long time to enjoy an interest-free loan. However if you carry a balance on your credit card, the grace period gets voided. From then on, not only will you pay interest on existing balances, new charges will also earn interest from day one. The only way to reset the grace period is to pay the card balance off in full.

7. Keep it simple.
Sounds like way too many rules to keep track of? Okay, here’s one simple short-cut to avoid reading up on complicated APR rules and still dodge all the pitfalls of credit card use: Use your card for purchases only and pay off the bill in full and on time every month, and you will never pay a penny in interest, even if you don’t know the first thing about credit card APRs.

(Updated 09-27-2011. Originally published 05-22-2009.)