Credit Card interest rates explained

What is credit card interest?

Interest is a charge for providing credit. All credit card accounts have an annual percentage rate (credit card interest rate). The applicable terms and conditions describe how interest is applied on a credit card account.

The annual percentage rate differs from product to product and different rates can be applied to the different types of transactions. For instance some bank products may have a different purchase rate and cash rate, or you may receive a special rate for a balance transfer. All of this is applied to the account's monthly aggregated balance to calculate the interest charge.

Interest charged by the bank can be divided into four categories:

  • Purchase interest - is interest charged on purchases such as food from the supermarket, paying bills or direct debits such as insurance premiums.
  • Cash interest - is interest charged on cash transactions such as ATM withdrawals, fund transfers to another account using internet banking or telephone banking, and bills paid over the counter at the bank, or post office.
  • Special interest - is interest charged on other amounts, such as a balance transfer amount from one banks credit card to another.
  • Interest on interest - is interest charged on interest charges shown on a statement of account which are outstanding and generated by the three categories above. Additional interest is charged on any interest charges, which are outstanding from the last statement period.

How is credit card interest calculated?

Credit Card Interest is calculated at the end of the statement period, and then charged to your account on the last day of each statement period. The banks start by working out the average daily balance (ADB) outstanding over the statement period. This is done by calculating the ending balance at the end of each day for all the transaction types, adding up each daily ending balance then dividing this by the number of days in the statement period. The banks then calculate the daily rate, they work this out by dividing each annual percentage rate (APR) applying to your card (i.e. standard rate, cash rate or balance transfer rate) by 365, number of days in a year.

Daily Rate = APR / 365. For example 18.15% APR / 365= 0.04973% daily rate.

The bank then multiplies the ADB by the daily rate. Finally, this number is then multiplied by the number of days in the statement period.

When is interest charged?

If interest is charged on your account it will be debited on the last day of your statement period. The first and the last day of each statement period is shown on your monthly credit card account statement.

What is an interest free period?

This is a feature of some credit cards which provides the opportunity to avoid paying interest on purchase transactions, by paying the account in full by the specified payment due date each month.

If your card has an interest free period, no interest will be charged on a purchase if:

  • You pay the full closing balance by the payment due date for the statement on which the purchase is listed, and
  • You have paid the closing balance of the previous statement by its payment due date.
  • The maximum interest free period for a low rate Visa Card is 55 days. 30 days being the length of a normal statement period, and then 25 extra days between the last day of the statement period and the payment due date in which to pay the account in full to avoid purchase interest.
  • If you did not pay the closing balance on your previous statement in full by the payment due date, your current statement will include interest charges for the outstanding balance, as well as any new transactions made since the closing date on that statement.

What if you don't pay the full closing balance by the due date every month?

If you have a credit card with an interest free period, you will be charged interest on purchases and cash transactions for that statement period, as well as on any new transactions made since the end of that period. This will continue to happen on future statement periods until your closing balance is fully paid in full on or before the due date of the latest statement.

If you don't have a credit card with an interest free period, interest is calculated daily on all transactions regardless of whether you pay the entire closing balance by the due date. Interest charges are debited to your account on the closing date of each statement period.

What if I pay the entire closing balance a few days after the due date?

If you have a credit card with an interest free period and you haven't paid the entire closing balance by the due date, you will lose the interest free benefit for that period. You will also be charged a late payment fee.

Before you apply for Credit Card

Before you apply for credit card, please check our site and compare credit card interest rates.

Published on January 1-th, 2009 in Credit Cards
Damon Rasheed is the CEO of Rate Detective, an Australian financial service comparison sites specialising in Life Insurance, Income Protection Insurance and home loans. Damon holds a Master's Degree in Economics from the University of Melbourne and has been involved in many start-up internet businesses.

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