Ever wondered why your credit card fees are high every time you miss a payment or don’t pay your balance in full? This month, I forgot to pay my credit card bill on time and to my dismay, I woke up with a $29.47 (interest + late fee) charge a day later. Absurd right? But it turns out that millions of people equally get surprised by really high credit card charges for not paying in full.
In fact, did you know that credit card interest (the price you pay for borrowing money) hit record highs this year, the highest it’s been in 20 years? This means that the amount your credit card company charges every time you fail to pay your balance in full increased. Well, why the surge in rates?
Banks Make a Profit From Credit Card Interest
Long story short, charging high interest on overdue balances is the easiest way for banks to make money.
In the past couple of years, banks haven’t been making that big of a profit on credit cards because of all the rewards they offer. You know, the sign-up bonuses, free travel, cash-back bonuses and other perks – don’t act like you didn’t sign up for a card because of it.
Anyway, these rewards are a dent to a banks’ profit, so they have to make up for the money by charging high interest rates. As of earlier this month, credit card interest reached its highest in more than two decades! According to Fed data, the average annual percentage rate, or APR (interest charged on credit cards) is about 17% and banks charge anywhere between 17-25% with the variance coming from different factors such as credit scores.
We All Got Debt!
In addition to this, research found that household credit card debt has surged in recent years and U.S. households on average owed $8,602 in 2019, up 8% from the same period of 2015 when adjusted for inflation. But how did we get to this state?
This is where it gets interesting. By looking at how interest is charged on balances owed on a credit card, it is easy to see why so many households have amassed a lot of credit card debt.
How Credit Card Interest is Calculated
Your credit card purchases are subject to a standard interest rate called the Annual Percentage Rate, or APR. Typically, APR measures interest over the time period of a year, but the measurement can still be used for longer or shorter time periods.
To find out how much interest you’re paying on your balance each day, convert your APR to a daily percentage rate.
To do this, divide your APR by 365 (number of days in a year).
At the end of each day, the credit card issuer will multiply your current balance by the daily rate to come up with the daily interest charge. That charge is then added to your balance the next day, a process called compounding.
Get ready for some math or USE THE CALCULATOR BELOW. If your credit card has an APR of 17%, it will have a daily rate of 0.046575% (17% divided by 365). Assume you have an average daily balance of $1,000. The next day, interest is added and the balance becomes $1,000.46, plus any additional purchases and minus any new credits or payments.
This process occurs each day until the end of your monthly statement cycle. So at the end of the month, the beginning $1,000 balance becomes $1,038.64 ( ~$27 late fee + $11.64 interest charge).
Keep in mind that a credit card could have several APRs for each type of balance. For example, in my case, I’m charged a 21.49% APR for purchases and 26.49% for cash advances. Generally, the APR for cash advances tends to be higher than the APR for purchases and balance transfers.
Some credit card issuers offer introductory APRs for purchases and balance transfers. The introductory rate is lower than the normal interest rate and lasts for the first few months of opening the credit card.
This past month, I forgot to pay my credit card bill on time (no, I don’t have a good excuse). As a result, the next day, I woke up to a late fee charge of $27 plus $2.47 for interest charges. Basically, I ended up being charged $29.47 just for paying A DAY LATE.
Beware of Store-Branded Credit Cards
Tempted to get a store-branded card for your favorite store because doing so will give you a 20% discount on your purchase? Think again!
Often, what retail stores don’t tell you is that these credit cards carry one of the highest interest rates. Miss one payment, and you shall suffer. Did you know that the average store card’s APR is now 26.01%, up 0.37% from a year ago and almost 9% higher than the average overall credit card APR of 17%?
While it might be tempted to get a store branded credit card because of a discount or sign-up bonus, in fact, 66% of adults in the U.S. got these cards for this reason, always think about the cost down the road. Given the interest these cards charge, you’re much better off with a general-purpose rewards card from your credit card issuer.
How to Lower Your Credit Card Interest
All is not doom and gloom. You have control over some of the factors that determine your credit card’s interest rate. A better credit score can get you better credit card options and if your score has improved significantly, you can try asking the issuer for a lower rate. But regardless of the stated APR on your card, you can reduce the effective rate several ways:
- Pay your bill in full every month, if possible, to avoid interest (GOALS)
- Make more than the minimum payment if you can’t pay your bill in full
- Make payments more than once a month to shrink your average daily balance
- Unless it is absolutely necessary, if you can’t afford it, don’t charge it