What is credit card interest and why should you care?
Credit card interest is the cost of borrowing money from your card issuer when you don’t pay your full balance by the due date. It’s like the price tag on the convenience of using credit, and boy, can it add up fast! The amount of interest a credit card charges is typically displayed in the user agreement when you sign up and when you log in to your online banking account.
Every credit card has an interest-free period. This timeframe lasts at least 21 days, but it can be longer depending on the card. Knowing how credit card interest works is vital since it’ll determine your overall carrying costs. If you abuse your credit cards and miss payments, you could quickly fall into debt, which also impacts your overall credit score.
In Canada, credit card interest rates typically range from 19.99% to 25.99% for standard purchases. However, it’s crucial to note that different types of transactions may have varying rates:
- Standard purchases: 19.99% - 25.99% APR
- Cash advances: 21.99% - 26.99% APR
- Balance transfers: Variable (often with promotional rates available)
These rates might seem high compared to other forms of borrowing, which is why understanding how they work is so important for managing your finances effectively.
Read more: Best low-interest rate credit cards in Canada
Types of credit card interest rates
Many people forget that there are different types of credit card interest rates. How you use your card will determine what the interest rates are. The following are the most common types of credit card interest rates:
Purchase interest rate (APR)
When looking at your credit card statement, you’ll notice that your interest rate is listed as an annual percentage rate—known as the APR. This is the standard rate applied to your everyday purchases. In Canada, it typically ranges from 19.99% to 25.99% APR. Remember, if you pay your full balance by the due date, you won’t be charged this interest!
Cash advance interest rate
Just about every card allows you to make a cash advance. This is where you can use your credit card to withdraw money directly from an ATM. However, most credit cards charge a few percentage points more than the APR for this service. For example, it’s common to see a credit card that charges 19.99% interest APR, and 22.99% for cash advances.
Besides the interest rate, the significant difference between cash advance interest rates and the APR is the grace period. With cash advances, you start accumulating interest right away. Additionally, purchases such as lottery tickets, gambling sites, and wire transfers are considered cash advances.
Balance transfer interest rate
When applying for a new credit card, some cards will allow you to balance transfer what you owe on an existing card to your new one. In addition, the balance transfer rate you’re offered can often be quite good. For example, your new card might provide you with 0% interest for 12 months when you transfer your balance.
This balance transfer interest rate applied when you transfer a balance from one card to another. It’s often lower than the standard APR, sometimes even 0% for a promotional period. But watch out for transfer fees!
Read more: The best balance transfer credit cards in Canada
Penalty interest rate
Many credit card issuers can increase your interest rate if you miss two payments (not necessarily consecutive ones). This penalty rate can jump by 5% to 10% above your standard rate, making your debt even more expensive.
How to calculate credit card interest charges?
To find out how you’re being charged, you need to look at your cardholder agreement. However, keep in mind that different financial institutions have different methods to calculate credit card interest.
Generally speaking, the following three steps will outline how to calculate credit card interest charges.
Step 1: Determine your daily interest rate
Even though APR stands for "annual percentage rate," interest is actually calculated daily. Convert your annual rate to a daily rate by dividing it by 365 (or 366 in a leap year).
For example, if your credit card charges 19.99% APR:
- 19.99% ÷ 365 = 0.0547% daily interest rate
Step 2: Calculate your average daily balance
Your interest charges are based on your average daily balance throughout your billing cycle. This includes:
- Any amount carried over from previous months
- New purchases
- Payments you've made
- Any other credits or charges
For each day in your billing cycle, your card issuer tracks your balance. These daily balances are then added together and divided by the number of days in your billing period to find your average daily balance.
Step 3: Calculate the interest charges
To determine your interest charge, multiply your daily interest rate by your average daily balance, then multiply by the number of days in your billing cycle.
For example:
- Daily interest rate: 0.0547%
- Average daily balance: $2,000
- Billing cycle: 30 days
0.0547% × $2,000 × 30 = $32.82 in interest charges
For a real-world example: If you maintain a $2,000 balance on a card with 19.99% APR, the interest would be calculated as follows:
- 0.1999 ÷ 365 = 0.00054 daily periodic rate
- 0.00054 × $1,000 = $0.54 per day
- $0.54 × 30 = $16.43 monthly interest charge
Remember, interest often starts accruing from the original transaction date, not from the due date on your statement.www.americanexpress.com This is sometimes called "reach back" interest.
How to save on credit card interest
While you can’t lower your interest rate, there are a few things you can do to lower your costs. Here’s how to save on credit card interest:
- Pay your bills in full and on time: You won’t need to worry about any interest charges if there’s no balance. Just pay off your full bill before the due date.
- Get a low-interest credit card: Credit cards are available with an interest rate between 8%-16%. This is a considerably lower interest rate than the average of 20%-22%.
- Balance transfer: If you’re carrying a balance, it can make good financial sense to do a balance transfer to a card with a promotional period interest rate.
- Make more than the minimum payment: If you must carry a balance, try to pay more than the minimum balance. Then, you won’t be charged as much interest as you’ll still be making a partial payment.
- Use a prepaid credit card– If you’re worried about interest payments, you could use a prepaid credit card instead. With these cards, you can only spend the funds you’ve already deposited.
Read more: Best prepaid credit cards in Canada
The true cost of credit card interest
To put credit card interest into perspective, let's compare different payment scenarios on a $2,000 balance with an 18% interest rate:
- Paying only the minimum ($60/month): Takes nearly 4 years to pay off with $793 in interest
- Paying $160/month: Takes just over 1 year to pay off with only $231 in interest
That's a difference of $562 in interest charges and nearly 3 years of debt!
The last word
Having a grasp of what is credit card interest and why it matters is essential, but it’s unlikely to be the only reason you apply for a credit card.
For borrowers who are currently carrying a balance, then the APR has a direct effect on them. Switching to a card with a balance transfer promotion or a low-interest credit card can help you pay off your credit card debt more quickly.
While credit card interest rates are important, it really depends on your individual situation. For example, someone who always pays their bills in full and on time shouldn’t care about interest rates since they’ll never be paying them. Instead, they should focus on the welcome bonus, earn rate, and any additional benefits that come with the card.
For borrowers who find themselves carrying a balance, the solutions above should help minimize, and eventually, completely pay down their debt.
Read more: Simple steps to get out of credit card debt in Canada
