Credit card interest explained

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Between rewards programmes and greater financial flexibility, credit cards have a lot to offer. But if you don’t know how credit card interest works, you’ll have a hard time maximising your card’s benefits.

In an ideal world, you’d never miss a monthly payment or carry a balance on your credit cards. Some people, however, do carry a credit card balance from month to month.

So, what’s the problem with carrying a balance? In many cases, it boils down to three letters: APR.



Interest and APR: A simple definition

Most credit cards come with an APR. Simply put, this is the price you’ll pay for borrowing money.

Credit card providers must tell you the cost of credit you take out, including your credit card interest rate as well any annual fees. Put together as a percentage and calculated over 12 months, this is known as the annual percentage rate, or APR. Though APR is expressed as an annual rate, credit card companies only use the card interest rate (and not the APR which includes fees) to calculate the interest charged during your monthly statement period.

Different types of interest and APR

There are other details in your card’s small print you should review to understand how much you could pay in fees if you’re not careful. Here’s what you need to know.

A credit card can either have a fixed APR or a variable APR. A fixed APR typically remains the same, but it can change in certain circumstances, such as if you miss your payment or if your payment is late. A variable APR usually changes with the Bank of England base rate. Many variable interest rates start with the Bank of England rate, then add a margin. The result is your variable APR.

Credit cards generally have several different types of interest rates you’ll want to look out for.

  • Purchase rate: The interest rate applied to purchases made with the card.
  • Balance transfer rate: The interest rate applied on the balance transferred from one credit card to another.
  • Cash advance rate: The interest rate applied to the amount of cash borrowed from your credit card. This tends to be higher and typically does not have a grace period – this means the interest is payable from the date you take the advance, and not the statement due date.
  • Introductory APR or introductory interest rate: The temporary promotional rates that some credit card companies offer to get you to sign up. This can apply to purchases and/or balance transfers for a limited time period, and is typically lower than the card’s regular interest rate — usually 0%.
  • Representative APR: The advertised rate that at least 51% of successful applicants will get. This means the other 49% could get a different rate and may have to pay more. The representative APR is intended to help consumers compare offers and includes both the interest rate and fees that have to be paid.

The purchase rate will be used to calculate how much interest you will pay on an outstanding purchase balance, if you have one. If you have excellent credit (for example, a score of 620 or higher on the TransUnion scale), you may be more likely to qualify for a lower interest rate because a credit card company may consider you a lower-risk customer.

If you have fair or poor credit, you may get a higher interest rate if you are approved for the card. This means it’ll cost you more every time you carry a balance with your card, so try to pay off your balance on time and in full every month, if possible.

How your credit card interest is calculated

Different lenders use different methods to calculate how much interest you’ll be charged. Typically, when you carry a balance on your credit card, the interest is calculated each day and added onto the balance you owe. That means the following day’s interest is then calculated on a higher balance than the previous day. This can add up quickly.

Credit card companies generally give you a grace period of about 56 days between the purchase date and when the payment is due. If you pay off your balance in full and don’t have any cash advances outstanding, you won’t be charged interest on new purchases made during this time.

Even if you can’t pay off your balance in full, consider paying off as much as you can to avoid late fees and reduce the overall balance subject to interest.

The minimum payment is typically a percentage of your balance — for example 3% or £10. For credit cards taken out since April 2011, minimum payments must be at least 1% of the balance plus that month’s interest, default charges and any applicable annual fees.

Some card providers impose a minimum monetary value — perhaps £5 a month. You should always aim to pay more than the minimum since the more you pay, the faster the debt disappears.


Next steps

Before you sign up for any card, know the interest rates and whether they are fixed or variable, and understand the factors that can allow your credit card company to change it.

And note that introductory APR periods don’t last forever.

Paying on time is a good practice in general. And aiming to repay debt as quickly as possible means you’ll pay less overall.