Finance > Credit Cards
Credit Card Interest Explained
The main cost associated with credit cards is the interest rate. Not paying off your balance in full before the due date will likely lead to this charge. Credit card interest rates may also vary depending on the type of transaction you make with your credit card.
In This Article
Interest Rates
Any spending on a credit card gets added to your ‘balance’. If you already have a balance from previous months, the new debt will be added to the existing debt. Each month, your credit card statement will display your balance, minimum payment and due date. You must pay the minimum payment before the due date, however it’s best to pay off as much of your balance as possible. If you don’t pay your balance off in full by the due date, you will likely be charged interest on the remaining amount (if you don’t have a 0% promotional period).
Annual Percentage Rate (APR)
A second rate to be aware of is the APR. APR is your cost of borrowing over a year and combines the interest rate with associated fees (e.g. annual fees). APR is measured the same across all lenders and must be displayed, therefore it is the figure you should use to compare credit card deals over 12 months. Having said this, the APR displayed is based upon the purchase rate, i.e. the interest rate applied to purchases of goods and services. Therefore it’s important to be aware that interest rates will likely vary if you use the card for different types of transactions (see below).
Differing Interest Rates
Interest rates may vary depending on the type of transaction that occurs.
- Purchase Rate
This is the rate that applies when you pay for goods and services. Not clearing your statement in full before the due date will usually result in you paying this interest (unless you are in a 0% promotion period).
- Cash Advance
Interest on a cash advance (e.g. ATM withdrawal) is usually charged immediately, regardless of whether you pay your balance back. You may also be charged an additional flat fee for taking cash out in some cases.
- Balance Transfers
Balance transfers allow you to transfer debt from an existing credit card onto a new card. You are likely to be charged a high interest rate outside of a promotional period if the debt isn’t paid off in time. An initial transfer fee may also apply.
Allocation of Payments
As interest rates may differ between purchases, cash advances and balance transfers. If you use your card for various transactions, the amount you repay will go towards clearing the most expensive debt first – known as the ‘allocation of payments’.
Example:
Let’s say the interest rates on your card are as follows:
Purchases: 18%
Cash Advances: 25%
You have a £200 balance, of which £150 is from purchases and £50 is a cash advance. If you make a £100 payment, the first £50 will be applied to the cash advance (due to the higher interest), and the remaining £50 will go towards purchases on the card.
Share This Article
Related Articles
Types of Credit Card
There are many types of credit cards, each with its own use cases and benefits, so it’s important to pick one best suited to your requirements.
What is a Credit Score?
Whilst credit scores are important to understand, the common misconception is they purely determine the outcome of a credit application; they don’t.
How to Check your Credit Report
There are multiple ways of accessing your report. This article guides you through accessing your report from the main credit reference agencies.