If you already have a credit card, you probably already know that the interest rate comes into play if you don’t pay the balance in full every month. But do you know how interest works?
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What is credit card interest?
Credit cards continue to be a expensive way to borrow money. When you don’t pay your credit card balance in full, credit card companies will charge you interest on the outstanding balance.
The amount charged will depend on what is known as the annual percentage rate, or APR.
For example, imagine you have an outstanding balance of £100 on a card with an APR of 15%. If the balance does not change for one year, you will be charged £15 plus the outstanding £100 balance.
How can I reduce credit card interest?
There are a number of different ways you can reduce credit card interest, though one of the most effective ways is by paying off the balance sooner.
Credit card interest rates are applied on a daily basis. The daily rate is the APR divided by the number of days in the year. So, the daily rate on an APR of 15% will be 0.041% (15% divided by 365).
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If you start with a balance of £100 that you don’t pay in full, you will incur £0.041 in interest, bringing the total to £100.041 after day one. On day two, you will be charged interest on the total balance of £100.041. This includes the interest after day one as well as the original balance. If this continues, after 30 days your balance will be £101.24.
In addition, the interest will increase if you continue to use the card for other purchases. Inversely, the balance will be reduced if extra payments are made.
What about choosing a new credit card?
The APR is used to compare the total cost of borrowing using different credit cards. You can compare different APRs as part of your decision-making process when looking to apply for a new credit card.
However, bear in mind that if you don’t have a good credit score, the company may increase the credit card interest rate. This is because the APR is advertised as being ‘representative’ so they can increase it if they think you might be a ‘risky’ borrower.
If you are in this situation, it is still worth getting a credit card, even if the APR is high. If you use your credit card responsibly over a period of time, this will help to improve your credit score. You will then be in a better position to negotiate cutting the credit card interest rate.
The APR is a good indication of the cost of borrowing when applying for a new credit card. However, if you are looking to transfer an outstanding balance, a card that offers an 0% interest-free period is the best option. Check out our best credit cards and cards offering an 0% interest-free period.
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