Credit Card Interest Rate: Formula & How it Works

What is Credit Card Interest Rate

Credit card interest rates, often referred to as Annual Percentage Rates (APRs), represent the cost of borrowing money from your credit card issuer when you carry a balance from one billing cycle to the next. This interest is charged on the unpaid balance and added to your outstanding debt. Credit card interest rates can vary based on factors such as your credit history, the type of credit card, and prevailing market conditions. It's essential to understand your card's interest rate, as higher rates can lead to substantial debt over time.

A Credit Card user bears the interest/finance charges in various scenarios. The interest rate levied on Credit Cards varies for different card issuers. As a cardholder, you should be aware of the rate of the charges applicable on the card. If you are a frequent Credit Card user or a new cardholder, here's what you need to know about the preset finance charges.

Credit Card Interest Rate Formula

The Credit Card interest rate is represented as the Annual Percentage Rate (APR) in the Credit Card statement. This is the charge applicable for the entire year rather than the monthly charge. The formula to calculate the interest rate is as follows:

(No. of days counted from the date of transaction x Outstanding Amount x Interest rate per month x 12 months)/365.

How does Credit Card interest work?

Often, cardholders are clueless about how the interest works in the case of Credit Cards. Let's understand when it is charged on Credit Card transactions.

Let's assume that the following is the scenario of a Credit Cardholder Mr A:

Transaction date | Amount – 2nd December 2021 | INR 10,000

Statement Date – 7th December 2021

Minimum Amount Due (5%) – INR 550

Total Amount Due – INR 11,000

Amount Due Date – 27th December 2021

Interest rate – 42% p.a.

• Case 1: If compete payment is made by the cardholder, there would be no interest charges.
• Case 2: If the cardholder is making only partial payment before the due date, then the Credit Card Interest Rate Calculation would be:
  1. Payment made – INR 5,500
  2. Payment date – 22nd December
  3. Next statement date – 7th January 2021
  4. Other Purchases made between 7th December and 7th January – None

Total Interest = (Interest on total amount from the date of purchase till partial payment date) + (Interest on the remaining amount from partial payment date till next statement generation Date)

Interest on full amount from purchase date till partial payment date (from 2nd December to 22nd December) = INR 265.8 [21*11000*42%/365]

Interest levied for 15 days (from 23 December to 7 January) on remaining amount INR 5,000 = INR 94.9 [15*5500*42%/365]

So, the total interest charged would be INR 265.8 + INR 94.9 = 360.7

• Case 3: If the cardholder pays the partial amount after the due date, then late charges, as well as interest rate, will be applicable. Assuming the following:
  1. Total payment made from the outstanding amount – INR 5,500
  2. Payment date – 29th December 2020
  3. Next statement date – 6th January 2021
  4. Transaction done between 7th December & 7th January – Nil

In this scenario, here’s how to calculate Credit Card interest:

Interest applicable for 28 days (Between 2nd December & 29th December) = INR 354.4 [28*11000*42%/365]

Interest charged for 8 days after partial payment date & till next statement date = INR 50.6 [8*5500*42%/365]

Total interest charged = 354.4 + 50.6 = INR 405

• Case 4: If the cardholder withdraws cash from the ATM, both interest rate and cash withdrawal charges would be applicable. Assuming the following scenario:
  1. Amount Withdrawn – INR 10,000
  2. Withdrawal Date – 2nd December
  3. Date of payment of withdrawn amount – 5th December

Number of days on which interest will be applicable = 4 (2nd December to 5th December)

The interest will be = INR 46.03 [4*10000*42%/365]

How do Credit Card Issuers determine Interest Rates?

The Credit Card interest rate varies from bank to bank. The interest on most credit cards is variable. Basically, if your credit score is better, you will be able to achieve a better rate on your credit card. While applying for credit card, knowing your credit score can help you determine best suitable credit card type In addition, it is important to understand what allows your credit card company to alter your card's interest rate. To determine the charges, you can use an online Credit Card Interest Calculator.

When is Interest Charged on Credit Cards?

Interest on credit cards is typically charged when you carry a balance from one billing cycle to the next and don't pay off the full amount by the due date. This balance, known as the outstanding balance, becomes subject to the credit card's Annual Percentage Rate (APR) or interest rate. The interest is calculated based on the average daily balance and added to your next billing statement. It's important to note that if you pay your credit card bill in full before the due date, you can avoid paying interest altogether. However, if you only make a partial payment or miss the due date, interest charges will apply to the remaining balance. Understanding when interest is charged and how it's calculated is crucial for maintaining good financial health and managing your credit card effectively.

Factors That Affect the Credit Card Interest Rate

• Credit Score: A higher credit score often leads to lower interest rates, reflecting your creditworthiness.
• Credit History: A strong credit history with on-time payments and responsible credit use can result in favorable rates.
• Card Type: Different types of credit cards, such as rewards cards or premium cards, may have varying interest rates.
• Market Conditions: Overall economic conditions and market interest rates play a role in determining credit card rates.
• Introductory Offers: Some cards may offer lower introductory rates for a limited period.
• Payment Patterns: Late payments or exceeding your credit limit may trigger higher penalty interest rates.
• Issuer's Policies: Each credit card issuer sets its own rates based on their risk assessment and business strategy.

Understanding these factors helps you make informed decisions and manage your credit card responsibly.

How to lower credit card interest rates?

Frequently using credit card for every transaction, can easily land you in a debt trap. Getting out of this debt can be expensive. You will be required to pay an interest rate in the range of 36-48% on the outstanding credit card bill. Failure to pay the outstanding dues will lead to an interest burden, but there are some ways you can lower the interest:

• Pay the Credit Card outstanding amount on the due date so that your interest remains nil
• Unless your outstanding dues are cleared, avoid making new transactions to decrease the interest
• Opting for Credit card EMI Facility for big ticket purchase helps to lower interest rates
• If you withdraw cash from the ATM using a Credit Card, you should pay back the credit early to avoid higher interest charges.

FAQs

What is the interest rate on a credit card?

The interest rate on a credit card, also known as the Annual Percentage Rate (APR), is the annualized cost of borrowing funds through the card. It represents the percentage of the outstanding balance that you'll be charged as interest over a year.

Is credit card interest rate charged monthly?

Yes, credit card interest is typically charged on a monthly basis. The monthly interest is calculated based on the average daily balance of your card during the billing cycle.

How does the interest rate on a credit card work?

The interest rate on a credit card is applied to the unpaid balance on your card. If you don't pay the full statement balance by the due date, the remaining amount carries over to the next billing cycle and accrues interest. This interest is added to your balance, increasing the amount you owe.

When is interest charged on the credit cards?

Interest is charged when you carry a balance beyond the grace period, which is the time between the statement date and the due date. If you don't pay the full balance by the due date, interest is applied to the outstanding amount.

When should I pay my credit card bill to avoid interest?

To avoid interest charges, it's advisable to pay your credit card bill in full by the due date mentioned on the statement. Paying the full amount before the due date ensures that no interest will be applied to your purchases.

Will interest be charged even if I pay the minimum amount due?

Yes, if you pay only the minimum amount due, the remaining balance will accrue interest. While paying the minimum amount helps you avoid late fees and maintain a positive credit history, it doesn't prevent interest charges on the remaining balance.

Will the rate of interest for credit cards change frequently? The rate of interest on credit cards can vary based on factors like market conditions, the credit card issuer's policies, and your credit profile. While some credit cards offer promotional or introductory rates for a specific period, regular interest rates may change over time.

In conclusion, understanding credit card interest calculation and knowing the factors that influence it can help you manage your finances better and avoid unnecessary charges. Use tools like an online calculator to calculate credit card interest and stay informed about credit card interest calculation to maintain healthy credit habits.