How does Credit Card Interest work?

1,240 Views Updated: 06 Sep 2017
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How does Credit Card Interest work?

Whenever you use a credit card, instead of spending your own money, you borrow funds from the company, which you have to pay in a stipulated time. What the company gets in return for lending you money is an interest which you pay when you purchase something to leave balance in your account at the end of a billing period.

While a vast number of Americans own a credit card, many times more than just one, most of them are unaware of the interest they are being charged for their purchases and balances. If you are one of those naïve people who do not know how credit card interest works, then it’s time you became wiser and understood how the world of credit card finances worked.

What Is Interest Rate?

All the purchases you make through your credit card are subject to a standard interest rate, which is referred to as the Annual Percentage Rate or APR (https://askopinion.com/what-are-the-best-credit-cards-with-0-apr). Depending on the card and the credit score (https://askopinion.com/whats-a-good-credit-score) of the cardholder, the APR can vary from person to person. Though the rate may be denoted as an annual measurement, credit card companies use it to calculate your monthly charges.

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How Is It Calculated?

How much interest you will have to pay on your credit card is calculated by calculating the interest you pay for each day. Meaning that if the credit card you are using comes with an APR of 15 percent, then the daily interest you will have to pay on balance in your account is 0.041096, calculated by dividing 15 by 365, the number of days in a year. The issuer of the credit card, at the end of each day, will calculate the interest charged on your balance. Then the next day, the interest is calculated on the total amount due, which is the sum of the original purchase value and the interest charge on the same previously. This means that your interest is calculated via a process called compounding.

Now suppose that you made a purchase of 1000 bucks with a credit card which charges you an APR of 15 percent. Since the daily interest, you will be charged 0.041096 percent of the balance, the amount you will be due the next day will be USD 1000.41. The amount may seem too small to some but remember that this is what you are charged for a single day. Therefore, at the end of the month, what you will own to the credit card company will be USD 1013.

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What Is The Best Time To Pay?

Almost all credit card companies offer a grace period during which if the bill due is paid, no interest is charged on the purchase. However, if the credit cardholder fails to make the payment on time or does not pay the entire statement balance, he or she fortifies the grace period, and the credit card company charges the interest, which is reflected in the following statement.

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What Else Should You Remember?

The cash advance balance and balance transfer balances of the cardholder may be subjected to separate interest rates and charges. In addition to that, if you fail to make payments on time, the credit card company may also impose a higher penalty interest rate. Another point to remember is that most credit card variable interest rate varies with the Prime Rate charged on the credit card. Prime Rate is interest rate three percentage points over the federal fund's rate set by the Federal Reserve Bank.

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Do you know how the credit card interest work and how it is calculated? Tell us through your comments is the dedicated section below.

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