Finance charges or interest charges are the credit card interest rate. It is the rate charged by credit card issuers on the borrowed amount. However, the interest charges are applicable only to those cardholders who don’t pay their outstanding in full.
For instance, if your credit card bill amount for a previous billing cycle is Rs.10,000 and you wish you make a partial payment, either minimum amount due (MAD) or even lesser than that, then the bank will levy finance charges as per its policy.
Hence, even where you make the minimum amount due on your credit card - interest will be charged to you as you have not paid back the full amount.
The good thing about using credit cards is that if you clear the entire outstanding on the card before the due date, you won’t be charged any interest. But if you’re someone who wishes to clear the dues at your own pace, you must know how much interest your bank charges, how it’s calculated and all other related information.
How Are Credit Card Interest Rates Calculated?
Credit card interest rate is calculated as the Annual Percentage Rate (APR) of charge. It is the interest rate for the whole year rather than a monthly rate. However, while calculating the interest rate for monthly dues, the monthly percentage rate (MPR) will be applied to the transactions. The APR and MPR vary from one bank to another and one card to another. While applying for a credit card, it’s important to know how much APR is being charged on a particular card.
What is Interest-Free Period of a credit card?
It is called the grace period, during which the balances on credit card do not attract finance charges provided the credit card holder repays the entire outstanding amount in full with the monthly credit card bill. The grace period varies with every credit card and usually is between 20 to 60 days. It is also called the interest free period.
For example, the Credit Card you hold has an interest-free credit period of 50 days. So, a credit card holder whose billing date falls on 15th of the month can spend on her/his credit card from 15th January to 14th February, and her/his bill will be generated on 15th February. Her/his payment due date will be 3rd March. Therefore a purchase made on 24th January will have a credit period of 40 days, while a purchase made on 10th February will have a credit period of 24 days.
Additional Charges other than the Finance Charges
- Late Payment Charges - If the MAD is not paid up to the due date, the late payment charges are levied. Late Payment charges are generally a fixed amount for the range of outstanding amount. It could vary from INR 500 to INR 1000 (depending on the credit card you hold).
- Over Limit Charges - If the total outstanding amount in a particular month exceeds the credit limit of the card, over limit charges can be a % of the overdrawn amount or a fixed fee (depending on the credit card you hold.)
When will interest be charged on your credit cards?
As mentioned earlier, if you pay the total amount due (TAD) on your credit card before the due date, the interest charges will not be applied. Let’s see the cases when the interest will be levied on your credit card transactions.
Case 1 - When you don’t pay the outstanding amount by the due date - You have to pay interest for the days the amount is outstanding and no payment has been made by you.
Case 2 - When you take a cash advance (cash withdrawal using a credit card) - If you withdraw cash using your credit card, you are availing the cash advance facility, hence, the withdrawn amount will attract finance charges from the date of withdrawal till the amount is paid back in full. There is no credit period/grace period for cash withdrawal. Interest on such cash withdrawal could be levied at anything between 2%-4% a month.
Case 3 - When you pay less than the Minimum Amount Due (MAD) on your credit card - If you wish to pay an amount that is less than your minimum amount due on your credit card, the entire outstanding amount will attract finance charges along with all the new transactions, till the previous outstanding amount is cleared in full. Additional late payment charges are levied.
Case 4 - When you carry forward any outstanding balance from the previous period to the next cycle - If you haven’t cleared your previous month’s outstanding in full, the bank will carry forward the remaining amount to the next billing cycle. In such cases, based on the repayment amount, either MAD or less than MAD, the interest rate will be charged on the outstanding as well as on all the new transactions, till the previous dues are cleared completely.
- It is very important to know that interest on credit cards is charged from the date of the purchase till the date of payment and not from the due date of the credit card.
- Interest is charged on whatever amount is pending after the due date - whether it is as small as INR 50 - hence, you must pay your credit card debt always in full.
- You will get a credit period of 40-45 days for every purchase but if you do not make full payment, interest will be levied from the date of purchase.
- Payment made is first adjusted towards interest, penalty and other charges and then it is adjusted towards the principal amount.
We have tabulated below an example of how interest is computed on your credit cards.
| Calculation of Interest & other charges on a Credit Card (@wealth Café working) | |||
| Period | Transaction | Amount (Rs.) | Amount (Rs.) |
| January | Purchase made on 10 January 2019 | 5,000 | |
| Total amount due on a statement dated 15 January 2019 | 5,000 | ||
| Minimum amount due on a statement dated 15 January 2019 (MAD is typically 5% of the TAD) | 250 | ||
| Payment due date – 3 February 2019 (no payment was made) | - | ||
| February | Purchase made on 7 February 2019 | 2,000 | |
| Purchase made on 10 February 2019 | 5,000 | ||
| On the next statement dated 15 February 2019, interest charges will be levied as follows | |||
| Interest on Rs.5000 for 35 days (from 10th January to 15th February) | 201 | ||
| Interest on Rs.1,000 for 9 days (from 7th February to 15th February) | 21 | ||
| Interest on Rs.500 for 6 days (from 10th February to 15th February) | 35 | ||
| Penalty Charges for the default in the month of January (not paying Minimum amount due) | 500 | ||
| Total Amount due on a statement dated 15 February 2019 | 12,757 | ||
| Minimum Amount due on a statement dated 15 February 2019 | 638 | ||
| Payment due date - 3 March 2019 (partial payment was made) | 5,000 | ||
| *this payment will not be mapped against the purchases of Jan directly but will first be adjusted against interest | |||
| March | Purchases made on 25 February 2019 | 2,000 | |
| Purchases made on 5 March 2019 | 3,000 | ||
| On the next statement dated 15 March 2019, interest charges will be as follows | |||
| Interest on 7757 for 28 days (from 15 February to 15 March) | 250 | ||
| Interest on Rs. 2000 for 18 days (from 25 February to 15 March) | 41 | ||
| Interest on Rs 1000 for 10 days (from 5 March to 15 March) | 35 | ||
| Total Amount due on a statement dated 15 March 2019 | 13,082 | ||
| Minimum Amount due on a statement dated 15 March 2019 | 654 | ||
| Payment due date - 3 April 2019 (full payment was made) | 13,082 | ||
Hence, the best way to deal with a credit card is to always pay your credit card dues on time. If you are stuck in a credit card debt, please understand the annual interest rate that you are paying on your CC.
Credit cards can be very beneficial when there is an immediate liquidity crunch and you have to pay your bills. The reward points are also good with your credit cards. However, the interest and penalty cycle is very vicious. So pay your dues on time, set reminders and make the most of your credit cards.
Wealth Cafe Actionable - Where you are stuck in a credit card debt and are unable to get out of it, take a personal loan which is way cheaper (interest rate is around 11% on your personal loan). Where you know you will repay in a month or 2, you can opt for a balance transfer from the existing credit card to a new credit card. It is important to know that such balance transfer also levies interest rates but they give a grace period of 30 - 60 days. Also, both these options will levy processing charges, hence do your calculations of what is the best way to get out of debt and work on it.
You must first clear your credit card debt. No return on any investment will be able to match the interest expense of a credit card. Hence, it is more important to pay off your debt first.