Owning a debit and a credit card is essential. While the former is used to buy things off your checking account, the latter can be used to make purchases on credit. Credit cards are considered lifesavers for many Americans, especially those who need financial help to make certain purchases. However, using this card isn’t as easy as it seems. You are often required to repay loans taken on the card every month. But what about interest? Do you pay interest on the card if you pay your bills completely every month?
If you end up settling your bills by the due date, you won’t have to pay any interest. Also, if you pay off your card in full every month, your card’s interest rate is insignificant. The charge will be zero, regardless of how high or low the APR is.
If you own a credit card by now, you should have understood how the interest rate works. However, this doesn’t apply to newbies who I suspect may be reading this now. If you just got your first credit card or you intend on getting one, there are several things you would want to know about your card, one of which is the interest rate. How does the credit card interest rate work? Do you need to pay interest if you settle your bills completely each month? I answered these common questions below.
Do You Pay Interest on a Credit Card if You Pay It off Every Month?
According to statistics, 70% of the U.S population owns a credit card, with 34% of Americans carrying three or more cards. Judging from this revealing stat, it is safe to say that not all Americans use a credit card. If you don’t use one of these cards due to age or personal reasons, then you may not know how these cards work. To assist you, I have provided a detailed explanation of what this card is, including how it works.
What Is a Credit Card?
If you own a debit card, understanding a credit card shouldn’t be difficult.
A credit card is a type of payment card in which charges are made against a line of credit instead of the account holder’s cash deposits. For example, when an individual uses a credit card to buy, say, a piece of furniture, the individual’s account accrues a balance that must be settled each month. Although failure to settle the debt incurred on the credit card early could lead to interest charges and late fees, a credit card can also help individuals build a positive credit history.
Remember, you need a good credit history for several financial reasons, including requesting loans with the best interest rates.
Deeper Definition of a Credit:
Credit is an indication of an individual’s ability to pay back their debt on time, which is described in a credit history put together by a credit bureau and indicated by a three-digit number popularly known as credit score.
The more credit score an individual has, the more purchases he can make using the credit because he is more trusted by lenders and banks. Often, credit is issued in the form of a line of credit, a stated amount that gets reduced by purchases each month and replenished by payments towards it.
How Does a Credit Card Work?
A credit card is the most common way to get a line of credit. Often issued by a bank or financial services company, credit cards let account holders initiate purchases on credit without putting up cash at the point of sale. Instead, the charge accrues as a balance that must be paid back on a monthly billing cycle, giving the buyer more time to gather the cash. The amount of a credit card line of credit (usually known as a credit limit) is determined by the card holder’s credit score and earnings.
When the credit holder settles his statement balance in full each month, he can expect his credit score to increase. As a result, he will be more likely to qualify for better loans at higher amounts and be approved for activities that need good credit, like renting an apartment, taking out loans, etc.
Furthermore, almost all credit cards have some kind of reward program in which account holders earn points for each dollar spent, which can be redeemed for cash back, frequent-flyer miles, or goods and services. These rewards may even be increased if the credit is co-issued by a bank and a retailer, in what is a co-branded card: points accrued may be worth more when used at the retailer who issued the card.
If the cardholder fails to pay his debt on time, the unpaid balance may start to accrue interest. Since credit cards fall in the category of unsecured loans (loans that aren’t backed up with collateral should the account holder default on what he owns), the interest rate changed to delinquent accounts is much higher than other types of loans, like mortgages. Not only will the balance and interest have to be settled, but late payments could reduce the account holder’s credit score.
As mentioned earlier, credit cards are usually issued by banks and financial institutions.
Common financial institutions that issue these cards are:
- Visa
- MasterCard
- Discover
- American Express
When banks issue credit cards, they depend on those companies to process payments.
Credit Card Example:
You see, almost all airlines participate in a co-branded credit card program, either issuing cards specific to their brand or as a part of a bigger suite of brands.
Delta, for instance, liaise with American Express to provide frequent-flyer miles via its SkyMiles brand with a Delta SkyMiles credit card. The card offers account holders complimentary benefits, such as early boarding on Delta flights and additional points on purchases made with Delta, like snacks on the plane. Although it boasts a yearly fee of $95, Delta often offers between 30,000 and 60,000 miles for new sign-ups, sufficient to make a domestic roundtrip flight.
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Building Credit History with Credit Cards:
Regular, non-secured cards and secured cards, when used appropriately, can help consumers create a positive credit history while providing a way to make an online purchase and reduce or end the need to carry cash.
Since both types of credit cards report payments and purchasing activity to the major credit agencies, cardholders who use their card appropriately can build strong credit scores and potentially increase their lines of credit, and in the case of secured cards, potentially advance to a regular credit card.
What is Credit Card Interest?
Right from our high school days, we were taught the concept of interest rate. As we probably know, interest rate is the amount a lender charges a borrower and is usually a percentage of the principal (the amount loaned). Such a definition is ideal when asked to define “interest rate.” However, it differs slightly when it comes to credit card interest.
You see, credit card interest is what credit card companies charge you for the privilege of borrowing money. It is usually indicated as an annual percentage rate or APR.
Most credit cards have variable APRs that fluctuate with a particular benchmark, like the prime rate. So, for instance, if your prime rate is 3%, and your credit card charges the prime rate plus $10%, your APR will be 13%. Recently, the average APR of credit cards as monitored by Investopedia’s database was 19.62%.
Do You Need to Pay Interest if You Settle Your Bills Completely Each Month?
With most credit cards, you are only charged interest if you fail to pay your bill in full each month. In that case, the credit card company charges an interest rate on your unpaid balance and adds that charge to your balance. So if you fail to pay off your balance completely in the next month, you will end up paying interest on your interest. This is how credit card balances can skyrocket fast and sometimes become uncontrollable.
To make matters worse, some credit cards charge several interest rates. For instance, they may charge one rate on purchases but another (often higher) one on cash advances.
How to Reduce Your Credit Card Interest Rates?
What is your credit card interest rate? Is it affordable or outrageous? If it is the latter, the chances are that you’ll want to find effective ways to reduce it. Below, I have highlighted seven effective ways to reduce your credit card interest rate.
- Make your payments in full and on time
Try to make your payments in full and on time (unless you have some go-ahead to omit a payment). Credit card companies can increase your rates if you fail to pay your debt early. They will be less likely to reduce your interest rates if this is the case as well. That is why it is crucial to often pay your bills early and completely. If you are deemed a debt risk, you won’t qualify for a lower interest rate.
Put simply, the steps for reducing your credit card interest rate are quite identical to that of increasing your credit score. For instance, you should concentrate on making your payments early and work on getting your balance lower so that you aren’t too close to the credit limit.
- Build your credit first if you need to
If you discover that your credit is less than optimal, you may want to work to build your credit health, so you appear more creditworthy to the bank. Try to keep your credit utilization rate (the percentage of your credit limit that you are using) at 30%, or if possible, less.
- Look for competing credit card offers
Credit card issuers and banks need to compete with other brands to get more customers. And what does this mean? It means these banks need to remain competitive with their rates.
Do your research and look at other available credit cards. If you find a similar card to yours that offers a considerable rate, note the card’s name, company, and terms. You’ll want to share this info when you contact the bank.
- Understand the credit card company’s perspective
You can better negotiate if you understand what the bank or credit card company needs on its end to agree to your request. For example, sometimes, a bank would need to ensure customers are creditworthy before choosing to reduce the interest rate.
- Don’t be scared to renegotiate in the future
Do you know John Rampton? He is the founder of Due. This man has successfully negotiated reduced rates for his credit cards and does so regularly. He says to expect to haggle and recommends you don’t give up after just one attempt.
From his vast experience, he claims that credit card companies seem more willing to offer lower rates when you request after making regular payments on your card for a minimum of six months. He follows up with requests every six months to ask for reduced rates until he gets a “no.”
- Call and table your request
Now you are prepared to get your credit card and call the customer service number listed on the rare. When you contact the representative, politely explain the reason for your call. If you have good credit, you can remind the rep of that and point to your history of being a good customer (by consistently using your card and paying your bills early).
You may want to share your info regarding the other offers available from other companies and explain why you may move your balance to a new credit card if you cannot get a reduced interest rate from them. You can also ask if they will at least match the interest rate on a competing card.
- Consider a balance transfer credit card instead
Balance transfer cards may offer you an alternative for getting a lower interest rate on your current credit card debt. This may allow you to consolidate your existing balances from several cards onto one new card.
You’ll want to use a credit card with a 0% introductory annual percentage rate, or APR, offer for balance transfers to save money on your debt repayment.
