When you use a credit card, you're borrowing money from the lender, up to an approved credit limit. So just like any other loan, interest may be charged on the balance.
How and when this interest is charged will have a big impact on how much it will cost you to use your card.
Interest rates are a fee that's charged when you borrow money. This means when you pay back what you owe, you actually end up paying more than what you've borrowed.
With credit cards, interest rates are calculated as a percentage of your balance at the end of each month, and shown as an annual or per annum figure. For example, a card could have an interest rate of 11.99% p.a. (per annum) or 21.99% p.a.
Most credit cards charge different interest rates for different types of transactions, with the most common being one rate for purchases, and a higher rate for cash advances.
Here's an example of a real life statement. In this example, the minimum due is $106. But the statement balance is $5,252,08. To avoid paying interest, you need to repaying that full amount of $5,252.08.
The way credit card interest is charged is known as "compound interest", meaning you could end up paying interest on your previous interest charges. The good news is that you can cut down on interest costs any time you make a repayment, because that will also affect the daily interest calculation you owe in the future.
If you don't think you can repay the balance in full each month, you may want to consider a low interest credit card.
Even the smallest difference in credit card interest rates can have a huge impact on your account costs. So when you're looking for a new card, make sure you compare both the standard and promotional interest rates to help you find one that suits your needs.
Credit card interest rates are high because for the lender, they carry more risk than secured loans. When they give you access to a credit card with a $5,000 limit, they are giving you access to spend that money on anything you like with virtually no restrictions, and they're not attached an asset to it that they could "repossess" if you don't repay the debt.
This is why credit cards are typically more expensive than car loans (attached to a car) or a home loan (secured by a property).
To show you how important it is to compare interest rates, let’s say you have a balance of $1,000 on a credit card with an interest rate of 20.99% p.a. If you only made monthly payments of $50 on this debt, it would take you around 2 years to pay off your balance and cost you about $212 in interest.
On a credit card with an interest rate of 15.99% p.a., it would still take around 2 years to pay off your balance but would cost you $153 in interest. That’s a saving of $59 compared to the card with a higher rate, which is basically another monthly repayment. The bigger the difference in rates, the greater these potential savings would be.
You can use this calculator to figure out how much you're paying on your current card, how much you could save with a low rate card, or how to plan your repayments and save yourself the most money.
The simple answer is that your repayments will go towards the balance attracting the highest interest first. So if you've made a cash advance which attracts a higher fee, any payment you make would go towards reducing this first. If you have a $200 cash advance and make a $300 payment, then the extra $100 will go towards the next highest interest balance, and so on.
For example, your payment would apply in the following order:
If you only have 1 interest rate for your entire balance (say, if you've only used it for purchases), you can use our calculator to figure out how long it would take you to pay off your credit card debt for your chosen monthly repayment.
The current payment hierarchy system has been in place since 1 July 2012, following credit card reforms. Previously, repayments would go towards the most recent transaction instead of the highest interest balance.
Two other important reforms were introduced at the same time:
Response | |
|---|---|
| Every month | 71.32% |
| Most months | 12.5% |
| About half the time | 6.62% |
| Rarely | 6.62% |
| Never | 2.94% |
As well as interest rates, make sure you consider the following when you're looking for a new credit card:
APR is the acronym for Annual Percentage Rate, which is the standard way of expressing the cost of credit as an annual percentage.
An interest charge refers to the interest fee you'll have to pay on your credit card account. This can be in the form of a purchase interest rate, cash advance interest rate or balance transfer interest rate and is calculated as a percentage of what you owe.
Compare your options. Use the table on this page to see Finder's selection of low rate credit cards, check out some reviews and find the right deal for you. If you've already got a credit card and you're paying too much interest, consider a balance transfer credit card.
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I have a Diamond MasterCard. My balance is $2700. I have paid $2500 on due date but charged $160. Is it correct? Why has this happened?
Hi Karu. It’s difficult to speculate why you’ve been charged this fee. Best to consult your credit card statement when it next arrives, or you can check your online banking facility to see why you’ve been charged this fee. If you let us know the name of the fee, we can offer some insight into why it has been charged, how to avoid it in the future, and maybe how to dispute it with the lender. Jacob.