One of the biggest costs of having a credit card is paying interest. Fortunately, knowing how credit card interest works can help you minimize or even eliminate the interest you pay on your credit card.
How Credit Card Interest is Set
Your credit card issuer assigns an interest rate or APR (annual percentage rate) to your card once you’re approved. Your credit card APR is based on your creditworthiness, or the likelihood that you’ll repay your credit card balance, as indicated by your credit score. The higher your credit score, the lower your credit risk, and the lower the interest rate you’ll qualify for.
Credit card interest is charged as a finance charge and calculated based on your balance an interest rate. The higher your interest rate and balance, the higher your monthly finance charges will be.
Different types of credit card balances can have different interest rates. You can carry three different types of balances on your credit card: purchases, balance transfers, and cash advances. Purchases and balance transfers often have the same interest rate while cash advances tend have a higher interest rate.
Avoiding Interest On Your Balance
Most credit cards have a grace period – a period of time that you can pay your credit card balance in full and avoid paying any interest on the balance. The grace period typically only applies to purchases you paid your previous account balance in full. You don’t get a grace period if you only paid a portion of your previous month’s credit card balance.
By law, the credit card’s grace period must be at least 21 days. Credit card issuers are also required to mail your credit card statement to you to give you enough time to pay your balance in full and avoid paying interest.
As long as you pay your balance in full each month, you will not accrue credit card interest. However, if you pay anything less than the full balance including the minimum payment, you’ll be charged interest on the balance the next month and each month after that.
Interest Paid on Cash Advances
A credit card cash advance is similar to a debit card ATM withdrawal. With a cash advance, you’re borrowing money against your credit limit, so you have to repay it.
Cash advances don’t have a grace period, even if you paid your credit card balance in full the previous month. The cash advance will start accruing interest from the day you made the transaction. And, since cash advances generally have a higher interest rate, you’ll pay more interest on the balance than if you made a purchase or balance transfer in the same amount.
How Can You Avoid Paying Credit Card Interest?
There are generally three ways to avoid paying interest on your credit card.
Take advantage of a zero percent interest promotion. If you have a pretty good credit history, you may qualify for a 0% APR promotional rate. Some 0% offers apply to only purchases or balance transfers and others apply the promotional interest to both types of balances.
You can lose your zero percent promotional rate if you’re more than 60 days late on your payment. Any balance you have left after the 0% APR expires will begin accruing interest at the regular APR.
Pay your balance in full each month. As long as your credit card has a grace period, you can always pay your balance in full each month and avoid paying credit card interest.
Avoid transactions without a grace period. Cash advances do not get a grace period. You’ll pay interest whether you pay in full or not. However, if you’re ever in crunch and have to take out a cash advance, pay it back immediately. If you start the next billing cycle with a zero balance, your grace period will kick in for purchases and you can go back to paying in full and avoiding interest.