Credit Card Interest Rates

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Credit Card Interest Rates

For the privilege of buying things on credit, you will be required to pay interest. The amount you pay depends on the size of your credit card balance.

The annual percentage rate

The interest rate is a charge that you will pay on any balance that is still open on your card. This rate is called the annual percentage rate (APR). It is the rate that you would pay over the course of a year, not what you would pay each month. What you pay each month is 1/12 of the APR; thus, if your annual percentage rate is 12%, you will pay 1/12 of that each month, which is 1%.

Variable rate

Most credit card APRs are variable, meaning that they change. They are tied to a specific foundation interest rate, such as the Prime Rate, a rate that banks charge to their most creditworthy customers. Added to the Prime Rate is the card’s own rate, so that the result is noted like this example: Prime + 6.9%.

The variable rate can change as the Prime Rate changes periodically. The way it changes will be described in the credit card agreement that comes with your card.

Most credit card companies still offer grace periods, in which the interest that normally accumulates is waived if you pay your bill in full each month. Savvy card owners like to ensure that their cards have grace periods.

How interest is calculated

Interest is calculated on your balance in a number of different ways; the method used is identified in your account statement. The balances used are these:

• Average daily balance. With this method, your credit card company adds up each day’s balance in the billing cycle and averages all of them.
• Beginning balance. With this method, your credit card company uses the balance at the beginning of the billing cycle. This means that any purchases and payments made during the month do not factor in.
• Adjusted balance. With this balance, any payments you make during the month are subtracted from your beginning balance.
• Ending balance. The credit card company uses the balance at the end of the billing cycle. This means that any purchases and payments made during the month do factor in.

A word about double-cycle billing: double-cycle billing calculates interest by taking the average daily balance from the previous billing cycle and factoring it into the current one, thus using two billing cycles instead of one. The recent Credit Card Act bans this.

And a word about trailing interest: also called residual interest, this is interest charged when the card company reaches back into your previous billing cycle and charges interest on balances already paid off. So, if you charged $2,000 and then paid off $1,999 during the grace period, on the next billing cycle you will be charged interest on the full $2,000. This practice is not used by all card companies, however.