Understanding Credit Card Interest Fees

Credit card interest is the cost a borrower pays to use a credit card. It's typically charged when you carry a balance past the due date of your billing cycle. The interest is calculated as a percentage of the amount owed, and this percentage is referred to as the Annual Percentage Rate (APR). The percentage rate can be fixed (the rate doesn’t change or variable (the rate will fluctuate), depending on the provider.

Most credit cards give you a grace period (usually around 21–25 days) during which the balance can be paid without incurring interest. This is generally the period within which your statement is produced and the payment due date.

However, if you don’t pay the full balance by the due date, the card issuer will charge interest on the unpaid amount.

Why Do Credit Card Lenders Charge Interest?

Credit card lenders charge interest to compensate for the risk they take when lending money, as well as to cover operational costs. When you carry a balance on your card, the lender essentially extends a short-term loan. The interest charged is how they make a profit. They’re offering you credit upfront with the expectation that you'll repay it over time. Interest rates also encourage timely repayment, as the longer you take to pay off your balance, the more expensive it becomes.

How is Credit Card Interest Calculated?

The interest is calculated daily or monthly, depending on the terms of your card, using the APR divided into a periodic rate. Here's how it works:

• Determine the Daily Periodic Rate (DPR)

The Daily Periodic Rate is the amount added for each day in the month to create your monthly interest charge. The Daily Periodic Rate is determined by dividing the Annual Percentage Rate by 365 days of the year.

Formula: DPR = APR / 365

For example, if your APR is 18%, the DPR would be:

18/365= 0.0493% (or approximately 0.000493 in decimal form)

• Calculate the Average Daily Balance (ADB)

The Average Daily Balance is the sum of your balance each day during the billing cycle, divided by the number of days in that cycle.

• Calculate the Interest

Formula: Interest = ADB × DPR × Number of Days in Billing Cycle

Tips to Minimise Credit Card Interest

Pay the Full Balance Monthly

Lenders will always advise you to pay your balance in full by the due date to avoid any interest.

It is important to note that a credit card is a lending contract between the lender and the customer. If the customer doesn’t respect their part of the contract, fees, also known as interest, will be applied. In other words, if a customer pays all their credit card balance a day after their payment due date, they will be liable to pay interest on the entire amount used.

Pay More Than the Minimum

In general, paying more than the minimum doesn’t stop the interest, but may reduce it as interest is only applied to the amount used on the credit card.

Avoid Cash Advances

Cash advance refers to cash withdrawals from ATMs and other types of transactions. Most credit cards allow you to withdraw cash from an ATM as you would with a debit card, up to a certain amount. This is known as a cash advance. These transactions always come with fees attached. Cash advance is not limited to cash withdrawals; it can also include buying foreign currency, spending money on gambling, including lottery tickets and scratch cards, share dealing, or buying cryptocurrency and more.