In an ideal financial situation, you’d never have to know about—let alone, pay—interest on your credit cards. That’s because you only get charged for your debts if you carry a balance from month to month. And when you pay off your bill, your balance is zero.
Of course, we live in the real world with real financial situations, and plenty of credit-card owners do carry a balance. In fact, as of the second quarter of 2019, Americans have racked up a whopping $868 billion of total credit-card debt, up $39 billion from the year before, per the Federal Reserve Bank of New York. And the average balance per card is $6,506, according to credit bureau Experian.
Understanding how interest applies to all those balances can help you manage your credit-card debt wisely and minimize your bills.
In general, your credit-card interest rate is what you pay for the luxury of spending the card issuer’s money while deferring the use of your own cash. It varies—both in terms of rates being different from card to card and person to person as well as each card’s rate periodically changing.
To figure out your interest rate, first look at the card’s annual percentage rate (APR). Some cards come with one APR for all customers. Others advertise a range of APRs, and each person’s rate is determined by their credit score with the higher scores earning the lower APRs. Also, many cards have different APRs for each type of transaction, such as for purchases, balance transfers, cash advances and late payments. Cards can also have introductory APRs, which are typically much lower, even 0 percent, but spike up after a certain amount of time, maybe even as little as six months.
The average APR on all existing accounts is 14.14 percent, according to WalletHub, but for all new offers, the average is 19.24 percent. Averages also vary based on credit scores, ranging from 14.41 percent for excellent credit to 22.57 percent for just fair credit. Card type also helps determine APR with student cards, for example, offering an average 17.61 percent and store cards charging an average 25.74 percent.
Most credit cards have variable rates, typically tied to the bank’s prime rate, which is often based on the federal funds rate. (Fixed-rate cards exist, but are rare.) That means that when the Federal Reserve (the central bank of the United States, also known as The Fed) makes headlines for cutting or raising rates, the APR on your card is very likely to change accordingly.
Welcome to the math portion of today’s lesson. Let’s say you have the averages noted above: a balance of $6,506 and an APR of 14.14 percent.
Divide your APR by 365 days. (Some banks use 360 days.) In this case, 14.14 divided by 365 gives us a daily rate of 0.039:
14.14 ÷ 365 = 0.039
Since it goes up each time you use your credit card (after any specified grace period) and down with each payment, your balance could change all the time. So you need to take the balance at the end of each day, add it all up, and divide by the number of days in that month’s billing period to find the average. Assuming our balance stayed at $6,506 every day, and this is a 30-day period, we get $216.87 for our daily average balance.
$6,506 ÷ 30 = $216.87
Multiply your average daily balance by your daily rate by the number of days in the billing cycle. Given our example: $216.87 times 0.039 times 30 makes our interest charge this billing cycle come to $253.74 total.
$216.87 × 0.039 × 30 = $253.74
To decrease your interest charges, you need to lower either variable used to calculate it.
The one you have the most control over is your daily average balance, which brings us back to our earlier point: Try to avoid carrying a balance. Paying your bill in full every month means you bring your balance down to zero and therefore accrue zero interest (while you boost your credit score). But even if you can’t cover the whole bill, paying off as much of it as possible brings down your average daily balance and shrinks your interest charge.
Your daily rate is more difficult to move yourself, but it’s not impossible. You’d just have to give the card issuer a call and try convincing them to lower it. If you’ve consistently paid your bills on time, and your credit score has jumped as a result, you can use that record of good financial behavior as evidence of your deserving a lower APR. You might even tell them about offers you’ve seen from other credit-card companies as a negotiating point.
Of course, your request may be denied, and your APR is ultimately in the hands of your lender. That’s why it’s important to carefully choose your credit cards before committing to them, being sure to compare the APRs (and other characteristics, including fees and rewards) of all your options. But it never hurts to ask—or to ask again.
Even if you do score a lower APR, you can reach out again periodically (even as frequently as every six months) if you continue to manage your credit responsibly and increase your credit score. And anyway, improving your credit score is always a good idea. Doing so can help qualify you for lower APRs on other cards and preemptively lower your interest charges.
The bottom line: Digging into the fine print of how credit cards work in general and how yours works, specifically, is an important move in managing your finances. By taking the time to understand these key points, you can be sure you’re doing all you can to minimize the cost of your debts while maximizing your credit opportunities.
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