How interest is applied to your credit card
Credit cards are easily accessible to most Australians, in fact at times it would seem that credit card providers are literally bombarding us with credit card facilities!
These little plastic cards enable us to buy anything within the credit limit, by making purchasing without needing to spend our own money upfront easier as long as the card balance is lower than the credit limit.
When signing up for a new credit card, you acknowledge this and agree to pay for your debt and any applicable interest applied to it.
With most credit card providers applying interest rates that are beyond reasonable to their credit facilities, problems start when one fails to clear their monthly card balance, the initial debt could get slapped with compound interest and the debt could balloon.
How can you determine your credit card’s interest rate?
Finding a credit card’s effective interest rate is fairly straightforward.
Different creditors and card types offer different interest rates. A credit card’s interest rate is usually indicated in the “Credit Card Key Facts Sheet” that issuers are required to provide applicants under the National Consumer Credit Protection Act 2009, which is administered by the Australian Securities and Investments Commission (ASIC).
loansHub offers a free credit card calculator to help consumers work out how much they’ll end up owing and paying in interest based on their balance and repayment amounts.
Credit card interest rates explained
Credit cards have varying interest rates depending on the issuer, type of card and transaction involved. Rates typically range from 11 to 20 per cent per annum (p.a.) and rewards cards are usually on the higher end of the scale.
According to Finder’s State of the Credit Card Market Report 2019, the average credit card balance owed by Australians is $3,258 with an average interest rate of 16.97 per cent. Based on the average balance, accruing interest portion payable by the credit card owner amounts to $1,986.
How do interest rates work on credit cards?
Notice that the interest rate range indicated above is “per annum”. This is usually how issuers show credit card interest rates because it’s how the interest adds up annually.
This however is misleading as interest is not applied to debt annually but on a daily basis and subjected to compounding interest effect.
What is compound interest?
Compound interest is when interest is added to the principal debt and the next interest payable is calculated based on this new amount. Repeat until the debt is paid off.
Consider this: Dan owns a credit card with a 20 per cent interest rate p.a. (0.0548 daily) and uses it to buy a $300 pair of sports shoes. If he only makes a minimum repayment of $7 for his purchase, he would only be able to pay off his original $300 debt in full after 13 years and two months.
The total payment will amount to $818, with $518 making up for the interest that compounded over time.
Can you negotiate credit card interest rates?
Responsible consumers who have a good track record of paying their credit card bill on time may negotiate a lower interest fee from the card issuer. All they need to do is pick up the phone and ask for it.
Before calling up your issuer, however, research different credit card offers that you are eligible for. Once you have compiled a list of ideal offers, you can call your issuer and negotiate to match the offer or end the contract.
Banks and other creditors spend more money attracting new lending customers than retaining them with customer care, so the chances of the issuer agreeing to meet their clients halfway are high. And if they don’t, change credit card providers promptly.
Word of caution, credit card is classed as an unsecured debt and making regular application to change providers will likely have a negative impact on your credit score and potentially reduce your home loan borrowing power .
How to reduce interest rates on credit card debt
Unfortunately, once a consumer has existing credit card debt, that amount is already subject to the interest rate they agreed to.
If borrowers can’t afford to meet the repayments, they should contact their creditor to ask for a financial hardship assistance and draw up a new debt repayment agreement for the amount.
They may also consider applying for a zero per cent balance transfer card, which can help them pay off the balance without accruing interest in a specified period. Sometimes, the original creditor may even try to match or outdo the balance transfer card’s offer.
Different credit cards apply different interest rates. It’s important to read the key facts sheet and compare various offers before applying for a specific card.
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This article via nestegg does not constitute advice; readers should seek independent and personalised counsel from a trusted adviser that specialises in property, a tax accountant and property design specialist.