When you obtain and use a credit card, one of the most important aspects to understand is how interest is charged. Credit cards allow you to borrow money and pay for your purchases over time instead of having to pay the full amount upfront. However, this flexibility does come at a cost - interest charges.
Annual Percentage Rate (APR)
The Annual Percentage Rate or APR is the key interest rate figure that determines how much interest you will pay on your credit card balances each year. The APR is expressed as a percentage and represents the total cost of borrowing on your credit card for one year.
For example, if your credit card has an APR of 18%, it means that for every Rs. 100 you owe on your card for one year, you will be charged Rs. 18 in interest. The APR remains the same throughout the year regardless of when in the year the balance was generated. Credit card companies are required to disclose the APR clearly on all promotional materials as well as on your monthly statement. There are certain banks that are very transparent when it comes to credit card interest rates. Choosing such banks could make your job easier.
Interest charges are calculated on daily balances
Unlike equated monthly installments (EMIs) where interest is calculated only on the outstanding principal amount, credit card interest is calculated on a daily basis. This means interest is charged separately every day on the outstanding balance that you carry forward each day.
At the end of the billing cycle (usually 25-30 days), your total interest charge is calculated by adding the daily interest amounts and levying this as part of your minimum amount due. So the longer your balance remains unpaid, the higher the cumulative interest charges become. Card issuers add any fresh purchases made within the billing period as well as applicable interest charges, fees, etc. to calculate your total outstanding balance. Paying just your minimum amount due each month results in interest being charged on revolving balances as well as new purchases month after month.
Grace period concept
Most cards offer a grace period feature where you can avoid interest on new purchases if you pay your total balance in full by the due date. During this period, which is usually around 25 days, you will not be charged any interest on new transactions posted to your credit card.
However, if any part of the previous month's balance remains unpaid, interest will be charged on that balance from the date of purchase as well as on all new transactions too. This is why it's always beneficial to try and pay your statement balance in full every month to avoid paying unnecessary interest costs.
Ways to minimize credit card interest charges
Now that it is clear how interest is calculated, here are some effective ways to reduce the interest burden.
Pay your full statement balance on time
As discussed, this allows you to benefit from the grace period and avoid interest completely on new purchases. Set up auto-pay to ensure timely payments.
Pre-pay amounts to reduce statement balance
Especially before statement date, pre-pay portions of your balance using the card's online portal. This lowers the interest charged on a smaller balance amount.
Compare APRs and switch to a lower-rate card
Check if your existing card's APR is higher than current market rates. If yes, transfer the balance to a new lower rate card to immediately reduce interest outgo.
Use credit card only for essential, budgeted expenses
Don't use it for unplanned purchases you can't pay off fully each month. Maintain credit utilization (total balance/credit limit) below 30% for a lighter interest burden.
With careful planning and monitoring of interest charges, you can maximize the benefits of credit cards and avoid piling up excess costs. Managing credit well also helps maintain a healthy credit score over time. Make sure to understand the charges when youapply credit carditself.
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