The interest rates on credit cards are high. Credit card companies like Capital One can make a lot of money when customers don’t pay their balance in full each month. That’s more money for them and less for you.
To stay ahead of this game, you have to use your card just like a debit card where you can only make purchases when you have money to pay it. But if you’ve already racked up a credit card balance that’s going to take a while to pay off, what do you do?
If you’re looking to learn how to avoid credit card interest, you’re in the right place. That being said, there’s a lot of background information that’s important to learn. You’ll need to understand how interest on a credit card works, why you should avoid paying it, and what measures you can take to get control of your credit card balances. So, without anything further, let’s dive right in!
How Interest Works on a Credit Card
Interest is the cost of borrowing money from a lender. Banking products like car loans, mortgages, and credit cards have an interest rate attached to this borrowed money. The Annual Percentage Rate or APR is how interest is typically shown on these various banking products.
The difference with credit cards is that this APR and interest rate are generally the same. When you make credit card purchases, your lender is actually making the payment for you. You have to pay back your credit card issuer. The bill includes these purchases and any interest that’s accrued.
When Credit Card Interest is Charged
Not paying your balance in full will leave an unpaid portion that carries over to your next billing cycle. This is what’s known as a revolving balance. Generally, this revolving balance will accrue interest.
Paying off this revolving balance or making more payments to pay it down will reduce the interest you’re charged. Interest isn’t just charged on every purchase you make.
There are APRs for other types of transactions that you make on credit card products. Credit card information about these different costs is listed on your credit card agreement.
Here are a few of the different APRs that you could be charged on your credit card:
Purchase APR – This is what’s charged for making purchases using a credit card. Most credit card products have a grace period built-in. This means if you make a credit card payment for the entire balance of your credit card statement, you don’t accrue any of these interest charges.
Balance Transfer APR – Balance transfers are when you transfer the balance of one card to another. Some credit card issuers offer a promotional introductory low APR on these transfers to entice people to get the card.
After this period ends, you’ll be subject to the regular balance transfer rate with is normally the same as the purchase APR. To avoid interest, you’ll want to pay your card offer beforehand.
Cash Advance APR – Your credit card is not linked to your bank account funds in most cases. So if you use your credit card to get cash at an ATM, this is the rate you’ll pay.
There’s usually no grace period so this interest typically starts getting charged the next day. In addition to this interest, which is usually higher than the Purchase APR.
Introductory APR – Another promotion that credit card issuers use to attract new cardholders is offering an Introductory APR. These credit card offers will typically have a lower intro APR for a limited time.
Depending on the offer, this intro could be for purchases, balance transfers, or both. Be careful not to understand what the offer is on these credit cards. For example, sometimes there’s a balance transfer fee that’s charged for every balance that’s moved over.
How Credit Card Interest is Calculated
How interest rates are calculated on credit cards varies by-products. You should refer to the information on your credit card agreement to find card-specific details.
The interest might be calculated daily or monthly. Some credit cards might use your average daily balance to calculate the interest rate. This is where your daily balance is tracked day to day, including adding charges and subtracting payments as they occur.
Once your billing cycle is over, these daily balances are added together then divided by the number of days in the billing period. This number is equal to your average daily balance.
How Credit Card Interest is Set
After filling out an application for a card and upon credit approval your interest rate is usually set. The information that’s found on your credit report including your history and your credit score are used by credit card companies to determine your interest rate generally. Having a higher credit score will usually equate to having a lower interest rate.
This interest rate could be variable or non-variable. With a variable APR, your rate is based on an index. The prime rate is a popular index that’s used among credit card issuers.
Any time this index goes up or down, the interest rate will change accordingly. The interest rate on a non-variable rate will stay the same for the most part. Check the information on your card’s terms to look for ways that this interest rate could change.
One example of a reason that your non-variable rate could change is if you miss a payment. According to the terms, your interest rate could go up due to these situations.
Why You Should Avoid Paying Credit Card Interest
The most obvious reason that you avoid credit card interest is that you are paying more on your purchases. That $10.00 meal at Chiptole just turned into $12.00.
As interest charges go higher, it also makes it difficult to pay your total credit card balance. If you have a balance then it’s probably going to take you longer to pay off your credit card. That means you’ll end up paying more interest.
Resolving a balance could also hurt your credit score. While different credit scores have different calculations, they all place a heavy emphasis on your credit card balance.
It’s best to keep your balance below 30% of your credit limit to avoid having your credit scores go down. If you’re in the market for a new home or car, having a good credit score will affect the interest rates on your loan. It could even affect your insurance quotes, which you’ll need for that new set of wheels or living space. If you feel like your credit may be too far gone already, you can also always consider using a credit repair software or company to assist with your financials.
How to Avoid Paying Credit Card Interest
There are many ways to keep from paying interest charges and accumulated credit card debt. Here are some ways explained below for you to try. Choose the best ones for your situation.
Pay your Balance in Full Every Month
It seems like a simple concept to avoid paying interest charges by paying your balance in full each month. This is the statement balance that’s found on your bill.
This must be done before the grace period ends which is outlined on your credit card bill as well. The standard length of grace periods is 21 days.
Use Balance Transfer Offers Strategically
If you carry a balance on some of your credit cards, credit card offers of 0% intro rates on balance transfer can be enticing. This is especially the case when you’re paying interest on this balance.
Using a balance transfer card can actually help get you out of credit card debt if it’s used the right way. The key is to pay off your balance before the introductory period ends.
Look at how long the terms are for – Whether it’s 6 months, 12 months, or more. Based on this information, add up all the balances you want to transfer to this card. Then divide it by the number of months.
Make sure that you can manage these payments to pay off the balance before this time ends. When used this way, you avoid interest and save money backing back your credit card debt. Think of strategy as an extended grace period to pay off your statement balance.
Make Good Use of Your Grace Period
Can you think of a loan product that allows you to borrow money for free? Credit cards can actually work this way.
Your grace period gives you well over a month to pay your balance. Typically this grace period will start on the last day of your billing cycle. It runs through the due date of that billing cycle which normally leaves you with three weeks after that period ends.
Most credit cards allow you to find the payment due dates and billing cycle dates on their mobile apps. Layout these various dates so that you can maximize your grace period.
For example, you could save your biggest purchase at the beginning of your card’s bill cycle. That will give you more time to pay it off without incurring interest charges.
Don’t use Cash Advances
Interest on cash advances doesn’t have a grace period which means they start accruing immediately. That is unless you want to consider that grace period to be that very day. If that’s the case, then did you really need the money anyway?
When you do a cash advance, there’s usually more than just interest you’ll be paying. There’s a fee for doing that cash advance in the first place.
Your terms will specify how much this is. Usually, credit cards charge a 5% cash advance fee based on how much is withdrawn. There’s usually a minimum fee of $10 that’s also involved.
The best thing to do is not use a credit card to do a cash advance. You’re not going to be able to avoid paying interest since there’s no grace period and it’s ultimately going to cost you more money to use this feature.
Pay for Your Purchases as you Go
While you could pay your balance in full every month, it might be easier to avoid paying interest by making a payment every time you use it. You can make as many payments as you want in a month.
This method does involve more work on your end, but it keeps you aware of how much is on your credit cards so you don’t carry a balance.
Create a habit of this that works best for you. You could make a payment every week or make it your daily habit. Your compensation for these efforts is that you never have a balance when your billing cycle closes and you never miss a payment.
Use Cards Only if You Can Pay in Full
Credit cards have bad negative connotations associated with them. But ultimately if you’re misusing your cards, it’s going to lead to a bad situation.
Before whipping out your card to pay for something, think about if you have the funds available to pay for it. If you’re not sure you can pay for the purchases you’re making, then it’s probably best to make them in the first place.
Another good option is to use your credit card for only certain types of purchases. For example, you could use it to pay for your gas and groceries each month.
That could keep your balances fairly consistent each month. Plus if you have a rewards card, you’ll earn cashback or points on these purchases that won’t eat eaten up by interest charges.
You should even consider starting a budget. This is especially helpful if you’re on a paycheck to paycheck cycle. A budget can show you areas where you’re overspending and help make a plan to pay down your overall debts. Budgets are just generally a great way to help reach your financial goals. To make budgeting even easier, there are tons of budgeting apps out there that can help simplify the task and keep you on track with your financials. Some options worth considering include PocketGuard, YNAB, Personal Capital, and Every Dollar.
Bottom Line: Avoiding Credit Card Interest
If you can avoid the trap of not paying your full balance each month, credit cards can be useful financial tools. But if you’re debt is rising, so are the interest charges you face. Still, it is possible to overcome this challenge by taking the right steps to improve your situation. With those lessons learned, you can keep yourself from paying credit card interest in the future.