How Do Interest On Credit Cards Work?

There are two ways credit card companies can profit. One is the fees they impose on merchants, eateries, and other providers of goods and services when you pay with your card. The interest and fees they charge you are the other. Here's how interest on credit cards works and how to pay less of it.

How does Credit Card interest work?

APR establishes the amount of interest that a borrower must pay on carried balances. The APR for your card is influenced by your creditworthiness. When compared to those with poor credit, those with excellent credit typically have low APRs. Low-score individuals receive higher interest rates because credit card companies see them as higher-risk customers. 

Interest rates and APRs are separate fees for mortgages and auto loans. However, interest rates and APRs are unchanged when it comes to credit cards.

Although the APR is stated as an annual rate, credit card companies charge interest with a compounding effect on average daily balances. Your monthly credit card statement will show the total amount of interest you must pay. You won't be charged interest if you settle the entire balance before the subsequent billing date.

Calculating Interest Rates for Credit Cards

The interest rate on a credit card in India is calculated based on the average daily balance of the cardholder. The interest is charged on the outstanding balance on the credit card, and the rate can vary depending on the credit card issuer and the type of card.

Here is the formula to calculate the interest on a credit card in India:

 Interest = (Average daily balance x Interest rate x Number of days in the billing cycle) / 365

 Where the average daily balance is calculated by adding the outstanding balance on your credit card at the end of each day in the billing cycle and then dividing the total by the number of days in the billing cycle.

The interest rate is the annual percentage rate (APR) charged by the credit card issuer.

The number of days in the billing cycle is the number of days between the statement dates for your credit card.

For example, if your average daily balance is Rs. 10,000, the interest rate is 40% per annum, and the number of days in the billing cycle is 30, the interest on your credit card would be calculated as follows:

 Interest = (10,000 x 40% x 30) / 365 = Rs. 667

It's important to note that some credit card issuers may charge a minimum interest amount, even if the interest calculated using the formula is lower. Additionally, some credit card issuers may offer a grace period during which you can pay off your balance in full without being charged interest.

Conclusion

Interest on credit cards is a fee charged on outstanding balances. It's calculated based on the average daily balance, interest rate, and the number of days in the billing cycle. Understanding this process is crucial to avoid excessive interest charges and effectively managing finances. Paying off the balance in full each month helps minimize interest charges.

Read More: Impact Of Late Payments On Credit Card Interest Rates

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