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Credit Card Interest Fees

There are a variety of costs connected with credit cards, but interest is likely to be the most significant. Simply said, if you use your card for purchases, balance transfers, and/or cash advances, you might be charged a lot of money in interest - particularly if you have a debt. Here's a breakdown of the three basic sorts of credit card transactions you may make, as well as how the interest costs connected with them are computed.

Fee - What is it? - How much?

Interest on Purchases: When credit cards are used to pay for products or services, interest is imposed on delinquent balances. After the grace period expires, interest begins to accrue and dates back to the day you made your purchase.Typically 19.99 percent, although depending on the kind of card, it might be lower (i.e. a low-interest credit card may only charge 10-12 percent).

Interest on Balance Transfers: The amount of interest charged on a debt moved from one credit card to another. The new card to which you transferred your balance charges interest, which begins accruing immediately.Typically 21.99 percent, although special discounts as low as 0% for a limited time may be available.

Interest on Cash Advances: When you use your credit card to withdraw cash, you will be charged interest. Interest begins to accrue the day you complete the transaction. Typically 21.99-24.99%

Credit card interest rates vary by transaction types

Aside from purchases, you may use your credit card to execute two additional sorts of transactions: balance transfers (when one credit card is used to pay off another) and credit card cash advances (when you take some of your available credit limit out as cash). Interest begins to accumulate immediately after the transaction in both circumstances. Balance transfers and cash advances have no grace period.

Credit card interest rates are often substantially higher than interest rates on other forms of borrowing, such as personal lines of credit or mortgages. On delinquent accounts, it's not unusual to pay an annual interest rate of 19.99 percent, and much more on balance transfers and cash advances. If you can't afford to pay off your whole debt at the end of each month, interest charges will appear on your credit card statement - and they may quickly build up.

How does credit card interest work?

"How does credit card interest work?" is a question that has to be answered. It's critical to understand that credit card interest may be computed in one of two ways: daily balance technique or average daily balance technique.

At the conclusion of each day, the daily balance method calculates interest on outstanding amounts. It's calculated by multiplying the daily interest rate (the yearly rate divided by the number of days in the year) by the daily balance, then adding the interest owing for each day of the month.

The average daily balance technique calculates interest by combining all monthly daily balances, dividing by the number of days in the month, and multiplying by the daily interest rate.

Let's look at an example of how both approaches are used to compute interest fees:

Case study: Daily balance method vs. average daily balance method

Late in December, John used his credit card to make significant purchases. He had a $8000 balance when he got his statement in early January. His card has a 15 percent annual interest rate and charges interest on a daily balance basis. How much interest will he owe in December if he does not pay off his debt in full by the conclusion of the grace period?

To use the daily balance technique to calculate how much interest John would owe, we must first calculate the daily interest rate by dividing the yearly interest rate by the number of days in a year (365):

15.00% interest rate ÷ 365 days in year = 0.00041%

The daily interest rate (0.00041 percent ) is then multiplied by the balance for each day. For example, if John owed $5,000 on December 24th, we multiply $5,000 by 0.00041 percent, which becomes $2.05. This computation is repeated for each day that John had a balance. The monthly total is then calculated by adding all of the daily interest costs. John would owe $23.78 in interest for the month of December if he used the daily balance approach.

Consider the identical scenario, except this time John's credit card utilizes the average daily balance technique. To begin, we must add the daily balances. We may eliminate days with zero balances, thus December 24th ($5,000) is the first day. To this, we add all of the remaining days in the month, as well as their balances:

$5,000 $6,000 $7,000 ( $8,000 5 ) = $58,000

The average daily balance is calculated by dividing $58,000 by the number of days in the month:

$58,000 total balance ÷ 31 days in month = $1,870.96 average daily balance

The daily interest rate is then calculated by multiplying the yearly rate (15.00 percent) by the number of days in the year (365), which equals 0.00041 percent. To find out how much interest is due every day, multiply the average daily amount by the daily interest rate:

$1,870.96 average daily balance 0.00041% daily interest rate = $0.767 interest owed per day

Finally, we multiply $0.767 by the number of days in December:

31 days in month $0.767 interest owed per day = $23.77 total interest

In this case, the average daily balance technique yields $23.77 in interest, which is almost equivalent to the $23.78 given by the daily balance approach.

Date        - Balance       - Daily Balance Method  - Average Daily Balance Method

Dec 1-23  $0.00         $0.00                         24 x $0.767 = $18.40

Dec 24 $5,000.00 $2.05                         $0.767

Dec 25 $6,000.00 $2.46                         $0.767

Dec 26 $7,000.00 $2.87                         $0.767

Dec 27 $8,000.00 $3.28                        $0.767

Dec 28 $8,000.00 $3.28                        $0.767

Dec 29 $8,000.00 $3.28                        $0.767

Dec 30 $8,000.00 $3.28                        $0.767

Dec 31 $8,000.00 $3.28                       $0.767

Totals                         $23.78                       $23.77

Even though there was no balance for these days, interest charges are included in our chart for December 1 to December 23 (24 days). We do this because we need to consider days with no balance when computing the average daily balance for a month.

Keep your eyes on your spending and your statement

You must do two things to properly prevent credit card interest charges:

Don't charge more than you can afford to pay off at the end of each grace period, and double-check every line of your statement and the payment due date each month to ensure everything is correct and you pay on time. It's easy to let a payment lapse because you weren't paying attention to the payment due date, even if you have the cash to pay off the sum in full. Unfortunately, depending on your amount, the interest costs incurred as a result of that error might eat into your following month's budget.