Sometimes using a credit card works like magic. Boom! We just bought a TV without actually having the money in the first place.
We see a big flat screen TV in the shop window, and we have to have it. But our current bank balance is not capable of handling that financial load. So, we use our credit card to make the purchase instead.
We all use our credit cards for different reasons.
Whatever the reason. You know why you have a credit card. But do you know how it works?
Having a credit card can be a useful tool, if you use it correctly. And that starts by knowing how your credit card interest works.
Everyone is charged a different interest rate. This is determined on your credit score and the repo rate (the interest rate at which the Reserve Bank lends money to other banks).
Knowing how much you pay in interest will help you manage your credit card better. And help get you out of the credit whirlpool if you ever get stuck…
How does Credit Card interest work?
We are charged with interest when we have an outstanding balance after the interest-free period. South African credit providers usually offer an interest-free period of 55-days. Sometimes credit providers may offer less, so make sure that you know what your interest-free period is.
This interest-free period depends on when you make your purchase.
If you make your purchase on the 1st of April, your interest will only kick in on the 25th of May. This means you have 55 days interest-free. But if you make a purchase on the 31st of April, you will only have 25 days interest-free.
Make sure you know how long you have before your interest starts kicking in.
Ideally, you should pay off your credit card debt before the grace period ends. This way you never pay any interest.
However, most of us don’t make that 55-day deadline and end up paying in.
So, how do we calculate our credit card interest?
Before we jump into the complex world of credit card interest. Let’s break it down so that it’s easier to digest.
First, we need to know what our annual percentage rate is…
What is Annual Percentage Rate?
Although the name suggests that interest is charged annually. The APR is simply the interest rate that banks charge you on a monthly basis. You can find this on your statement.
The APR only jumps into action after the 55-day interest-free period.
Knowing your APR is important.
This is because credit card interest is compounding. Meaning you pay interest on interest as well as your outstanding balance.
But… your interest isn’t charged annually. Instead, it’s daily. This is called your daily periodic rate.
How to calculate the Daily Periodic Rate?
The DPR is added to the previous day’s balance. This is because interest compounds daily.
To calculate the DPR divide your APR by the number of days in the year.
Let’s say that your APR is 17%. Divide that 17% by 365. This would give you a Daily Periodic Rate of 0.046%.
So, we’ll be paying an additional 0.046% in interest on our credit card balance per day.
More interest, means more debt
Interest is how credit providers make their money. The more you use your credit card, the more money you make them and the more debt you make for yourself.
And because of compound interest, that debt will keep increasing.
This can become a vicious cycle.
Avoid building compound interest on your credit card payments. Simply spend enough on your credit card so that you can pay back what you’ve borrowed during the grace period. Remember, you’re only charged interest after that period.
If you’re struggling to get those credit card payments down. Get in touch with us today and we’ll help you manage your debt and get you out of that vicious credit cycle.