Understanding Credit Card Interest
Part one of this credit card series discussed specific terms related to credit cards and how to choose the right one for you. Part two will outline credit card interest and the importance of building your credit score.
What Is Credit Card Interest?
You might be familiar with interest in terms of when you take out a loan. It’s a similar concept when it comes to your credit card interest. In general, interest on loans will be lower than interest on your credit card.
Where the two interests vary is in the monthly balances. Your credit card statement will likely vary each month whereas a loan payment will be the same. With your credit card payments, you have a minimum amount that must be paid each month.
You’re not typically required to pay your statement in full each month, but any unpaid balance will carry over to the next and accrue interest. If you’re unable to pay the full amount each month, you’ll end up paying more than what you’ve spent because of the interest.
That’s why for the best credit card success, each month you should only spend what you’re able to repay by the end of the month.
Understanding Interest Rates on Your Credit Card
There are three types of interest rates you could have on your credit card. Generally, the interest rate will either be fixed or variable. When you first sign up for a credit card, you may receive a promotional interest rate.
Fixed-rate – Your interest rate or APR will not change without notice. This type of rate is dependent on your credit card company rather than the market.
Variable Rate – On the other hand, a variable interest rate will change whenever the index interest rate changes. Additionally, a credit card company can change your rate without giving any notice or warning.
Promotional Rate – You may be asking yourself, how to save on interest when using a credit card, and to do so, you may opt for a card with a limited time promotional rate. Diamond offers 1.99% APR* for the first year on all qualifying purchases, cash advances and balance transfers. Variable rates ranging from 12.90% to 18% APR* applies thereafter.
Credit Card Companies and Interest Grace Periods
Although it’s not required, a lot of companies will have a grace period. This allotted period is the time between the billing cycle and when the payment is due. During this time, you will not be charged interest on new purchases.
This grace period is only applicable if you pay your balance in full. If you don’t pay your entire balance, you risk losing this grace period and acquiring interest on all of your credit card purchases.
How Is My Credit Card Interest Determined?
Generally, you’ll be charged one interest rate for credit card purchases and a separate interest rate for using your credit card to get cash or to write a check with your credit card account.
Companies will likely determine your interest based on your average daily balance. This type of interest is called the daily periodic interest rate. When you’re first looking for a credit card, you’ll see an APR, which will be your annual percentage rate.
In order to determine your daily periodic interest rate, simply divide the card’s APR by 365, or use an online calculator.
Now, to understand what interest rate goes with each purchase, you can find different categories on your statement. Your statement will show you the balance for each category so you can get a better idea of where you’re spending your money.
The Importance of Paying Off Your Credit Card Debt
Now that you have a better understanding of credit card interest, the next step in this guide is the importance of making sure you’re not letting your credit card debt build up over time. Not only is this crucial so you’re not paying more with higher interest rates, but lots of credit card debt also negatively impacts your credit card score.
Good credit scores affect more financial situations than you may think. If you’re looking to acquire a loan with a poor credit score, it could mean you’re paying higher interest rates and have fewer loan options.
On the other hand, with a good credit score, you may see lower interest rates, higher limits and premium credit benefits. Outside of credit cards, you’ll also find a better credit score means you can easily be approved for loans, receive close to the starting interest rate, and even get a lower homeowner’s insurance premium.
Factors That Make Up Your Credit Score
Understanding your credit score is crucial to credit card success. We’ve already discussed the benefits of lower and strengthening your credit score, but without knowing what goes into your score, it will be hard to achieve your financial goals.
Below, we list the five factors that make up your credit score. Then, you can take actionable steps to improve your credit.
Payment History – This is the biggest influence on your credit score (35%), which means it’s essential to pay your statements on time. The bottom line is, the more you pay your credit card payments on time, the higher your credit score will be.
Amounts Owed – If you’re using a high percentage of your credit limit, it will negatively impact your credit score. So, try not to consistently reach your credit limit. If you are starting to reach your limit consistently, you can look into opening another credit card account to spread out your spending.
Length of Credit History – This factor is something that will only improve with time. 15% of your credit score is calculated by how long your credit accounts have been open and how long it’s been since you have used that account.
New Credit – If you open a bunch of new accounts at the beginning of your credit journey, it will negatively affect your credit score. So, start with one or two accounts and slowly build up from there, if necessary.
Credit Mix – There are different types of credit accounts you can have, and having a mix can improve your credit score. However, not every credit account is necessary and this factor only represents 10% of your overall credit score.
A best practice for credit card success is to regularly check your credit score and how it changes over time. At Diamond, we can help you review your credit score and review loans and credit history to make changes for the better.
Now that you have a better understanding of credit card interest, you can take what you’ve learned and apply it to your own situations. Building your credit score is important and very beneficial for your future self, but it can also be a slippery slope if you’re not careful with your credit card debt.