A Quick Guide to Credit Card Interest

To get the most out of credit card offers, it pays to spend a little time educating yourself about the terms and conditions offered before you apply. In particular, understanding the terms related to credit card interest can save quite a bit of money over time.

Here are the five most important things to know about the card’s interest before you apply for them:

1. What is the Annual Percentage Rate or APR?

The credit card interest rate is essentially the fee credit card issuers charge for the money borrowed on the card. Interest is expressed in terms of an annual percentage rate, more commonly known as the APR. The APR is the percentage interest paid per year on the money borrowed on the credit card.

For a simplified example of APR without compounded interest, see the table below.

As this example shows, the APR, or yearly interest, makes a big difference in the interest charges paid during the year. This simplified example doesn’t take into account compound interest, which causes the actual credit card interest paid on the card to be higher. We’ll go into more detail below.

2. What is the minimum monthly payment?

Credit cards are so popular, because you can keep a balance on your credit cards and pay it off gradually over time. The minimum monthly payment is calculated as a percentage of the current balance on the credit card, typically around 2%. As you pay the balance down, the minimum payment also goes down, as long as you don’t put any additional charges on the card.

3. What is the default interest on a credit card?

Credit card companies charge penalty fees if the minimum monthly payment isn’t paid on time. Even if the credit card payment is just a day late, you will be charged a late fee, which may range from $19 to $39.

If payments repeatedly are late or if one credit card payment is very late, typically more than 30 days, your credit card interest rate will revert to a default rate. Default credit card interest rates can be as high as 29.99% or more.

4. What is the effect of compounded interest?

Paying just the minimum monthly payment every month is a little bit 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.

Worse, the credit card interest compounds, which means that you also pay interest on what accumulates every month. This means that with just paying the minimum payment, it will take a very long time to pay off your card balance.

Want to know just how long? Use this convenient calculator to find out how long it will take to pay off your credit card at your current interest by making just the minimum monthly payments.

5. How long is the grace period?

Savvy credit card users avoid paying credit card interest all together. How? The trick is to stay within the credit card’s grace period. The grace period is the time allowed from the moment a purchase was charged to your credit card to when credit card interest begins to accrue.

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, there is no grace period.

In short, the only way to enjoy the grace period is to pay off your credit card in full every month. And that’s not such a bad habit to have anyway.

Published: May 22, 2009