How Are Credit Card Interest Rates Calculated?
A credit card is particularly convenient when you don't have sufficient cash available or paying upfront is not an option. You can use your credit card for online shopping or to cover unplanned expenses. There's something you should understand about credit card interest rates. Interest is additional money you must pay if you fail to repay your card balance on time.
Understanding interest rates helps you avoid paying more than necessary and maintain healthy finances. Let us understand exactly how these interest rates function and impact your monthly payments.
What is a Credit Card Interest Rate?
The credit card interest rate is when the bank or issuer charges the outstanding amount if it is not paid in full by the end date. Often simply referred to as the Annual Percentage Rate (APR), this rate can vary from approximately 24% to more than 48% in India, depending on creditworthiness and the card type.
Daily Interest Calculation Explained
As opposed to other loans, credit card interest rates are figured on a daily basis and, thus, are slightly more complicated. Your bank converts your APR into a daily rate by dividing it by 365 days. For instance, if your card carries an APR of 36%, your daily interest rate would be about 0.0986% (36% ÷ 365 days).
To determine daily interest, banks multiply the rate of the day by your current balance. With an unpaid balance of ₹10,000, the daily interest will be approximately ₹9.86. This money is accumulated daily and added up when your billing period ends.
How Interest Adds Up Over the Billing Cycle
Every time a billing cycle ends, banks add up daily interest charges to determine your monthly interest. Assuming you have an unpaid balance throughout the 30-day billing cycle. Your last month's interest in the above example (₹9.86 per day) would total around ₹295.80.
This built-up interest is added to your current outstanding balance, and you owe more. Paying only the minimum amount due means that the remaining balance will again accrue daily interest, and you could pay a very substantial sum over time.
Interest-Free Periods and What They Do for You
All credit cards have an interest-free period, which usually ranges from 20 to 50 days. Paying within this time has no interest whatsoever if the entire outstanding balance is paid before the due date. But if payment is not made in full, interest is charged from the purchase date.
Recognising and using this interest-free window judiciously can minimise or even avoid the interest paid, getting the best out of your credit card.
Why Interest Rates Differ Between Credit Cards
Not all credit cards offer the same interest rate. Various reasons account for these differences:
● Creditworthiness: Those with better credit scores typically benefit from lower rates.
● Type of Card: Higher-end cards or those with high rewards tend to have higher rates.
● Issuer Policies: Every issuer or bank also has its own set of policies and risk appraisals, which affect the structure of interest rates.
Knowing about these factors allows you to select a card that is most appropriate for your spending patterns and repayment capacity.
Cutting Down on the Interest Burden
Paying your credit card bills wisely can go a long way in eliminating interest charges:
● Always try to pay your complete outstanding amount on time every month.
● Avoid withdrawing cash using your credit card, as this attracts high interest immediately.
● Regularly monitor your spending to avoid going beyond your repayment capacity.
Conclusion
Being knowledgeable about how credit card interest rates work allows you to use your card wisely, minimise unnecessary charges, and make the most out of the benefits it offers. Understanding finance is important in making informed choices, which eventually leads to good financial health and stability.
Disclaimer: This article is published in association with Axis Bank and not created by TNM Editorial.