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Interest Rates and Your Credit Card: 5 Fast Facts

    One of the biggest surprises that consumers face when getting a new credit card is the amount of interest that is charged on the card. Although many cards today offer a grace period for purchases where no interest occurs if the balance is paid off, there are a number of consumers who carry a balance on their card from month-to-month and this causes interest to be charged. When you see an APR of 9.99%, that seems like a pretty good deal, right?

    What Is the APR?

    APR stands for “annualized percentage rate.” In simple terms, it’s a look at what you’d pay in interest for every $100 you have in debt on your line of credit. With a standard 19.99% APR that you’ll find with most credit cards in Canada, it means that over the course of a year you’ll pay $19.99 for that $100 in debt. This annualized percentage rate is broken into 12 monthly chunks that are then immediately applied to your debt.

    The one problem that exists when considering this interest rate as a measurement of how much interest you’ll pay is that it doesn’t take into account what is called the “compounding effect” on your rotating balance. You see, your overall balance on the credit card, if you rollover just one month of debt, is going to have more than just purchases on it. It’s also going to have interest fees that you’ll be paying and interest becomes immediately capitalized, or added to your balance of debt, with a credit card.

    The surprise comes when the monthly statement arrives and there’s a massive interest charge that’s been included with the outstanding balance.

    How did interest charges get so high on a credit card?

    Here are 5 fast facts about credit card interest rates you need to know.

    #1. Many credit cards offer interest rates that are variable. The variable rate APR is based on what is called the “prime interest rate.” What the lender does is offer a fixed upcharge of interest above this prime rate and this can vary every month sometimes. This means you might have a 14.9% APR above prime, but if the prime rate climbs to 5%, your actual interest APR would be 19.9%.

    #2. Most cash advances have no grace period. Unlike purchases that may have a grace period of 21 days or more, cash advances are typically charged interest from the day that they are made. To limit your expenses, avoid using your credit card for a cash advance if at all possible as they also tend to carry with them a higher APR.

    #3. Credit cards apply payments to interest and fees first, not the overall balance owed. If you don’t make a full monthly minimum payment, then the amount that you do pay will go toward interest rates and fees first. You’ll likely have a late payment fee included on your next month’s statement as well. If at all possible, pay down purchases before the monthly due date so you can limit the amount of interest that is charged on those items.

    #4. Penalty APRs kick in from the moment you qualify for them. Some credit card lenders are offering a penalty interest rate for those that have missed just one or two payments. It is a higher APR, usually 5% or more, and applies until you are able to meet the standards of having your account be considered in good standing once again. This typically means that you’ll need to make 12 consecutive monthly payments on time and for the minimum amount due before you’ll qualify.

    #5. Interest builds on other interest. The reason why it takes so long to pay down a credit card if you just pay the minimum amount due every month is that interest charges are also charged on previous interest charges. The minimum amount is typically just 1-2% of your balance due plus all of your interest charges that were charged daily for the month. If you’re trying to pay down debt, having a second payment mid-month can really help, even if it is just for a small amount.

    By knowing what interest rates are and how they are charged, there will be fewer surprises that occur when you open up your bill for the month. Use this information to plan as you manage your credit and you’ll be able to stay financially strong.

    So what’s a solution?

    Many credit cards have a grace period that is a minimum of 21 days. Some lenders allow for an even longer grace period on purchases and sometimes even balance transfers. This means that you have the opportunity to directly pay off the purchases you’ve made within that time. If you do, then you won’t be charged any interest!

    Why Is This Important To Know?

    If you’re judging how much you’ll need to pay monthly based solely off of your APR, then you’re going to be underestimating how much it is that you really owe. You’re paying interest rates that exist on top of the interest that has already been charged. The more you debt you carry, the larger this annualized yield will be in comparison to your APR.

    Take a look at the APR section of your credit card statement. You’ll see what your current interest rates are and how much has been added to the debt that you’ve rolled over to the next month on your line of credit. Instead of paying the minimum monthly payment, which may not fully cover the amount of interest that has been charged in some cases, pay the full amount of interest that has been added to keep this compounding effect as limited as possible.

    The bottom line is this: a lower balance of debt every month will result in fewer interest charges, no matter how high your APR happens to be. Utilize the grace period as much as possible, pay off your purchases quickly, and turn your credit card into a financial tool instead of a debt accumulator.

    Christopher - BSc, MBA

    With over two decades of combined Big 5 Banking and Agency experience, Christopher launched Underbanked® to cut through the noise and complexity of financial information. Christopher has an MBA degree from McMaster University and BSc. from Western University in Canada.

    Christopher - BSc, MBA

    Christopher - BSc, MBA

    With over two decades of combined Big 5 Banking and Agency experience, Christopher launched Underbanked® to cut through the noise and complexity of financial information. Christopher has an MBA degree from McMaster University and BSc. from Western University in Canada.