You know that it's desirable to have a high credit score in order to get a low credit card interest rate, but do you know why your credit score is important — or how the interest on balances is calculated?
Tiffany Aliche, Financial Educator and Author also known as "The Budgetnista", explains the thinking of credit card issuers: "If you have a higher credit score, that means you are more likely to pay back. And if you are more likely to pay back, they are more likely to lower your interest rate...if you are not likely to pay back, people want their money upfront." If you're not sure what your credit score is, you can check it and read your credit report for free within minutes using Credit Manager by MoneyTips.
When a credit card company considers you higher risk, you will be offered a higher annual percentage rate (APR). That APR is indirectly used to calculate the interest on your balances.
Most card issuers divide the APR by 365 to produce a daily periodic rate (DPR). That daily periodic rate is applied to your average daily balance for the entire billing period to determine your interest charges for the month.
Consider this simplistic example. Assume your credit card has a 14.6% APR. Divide that by 365 days to get a DPR of 0.04%. If your average daily balance were $1,000, your daily interest charges would be $1,000 x 0.0004, or 40 cents per day. Given a 30-day billing cycle, your total interest charges for the month will be 30 x $0.40, or $12.
Carrying a balance affects your total interest in more subtle and long-lasting ways, because it eliminates the effects of the grace period — the time gap between the end of a billing cycle and the due date of the payment for that billing cycle (typically around 25 days).
When you pay your bill for the previous billing period by the due date, there are no interest charges applied to purchases that you make during the current cycle. If you fail to pay the previous billing cycle by the due date, interest begins accruing on your current purchases the day that you make them, thus increasing your monthly balance for the current period. Depending on your credit-card terms, it may take a full two months of paying in full by the due date in order to restore your grace period.
You must also consider "trailing interest"; the amount of interest accumulated over the days between the end of the cycle and the date your payment for that cycle is received. For example, if your billing cycle ends on the 15th of the month and you pay the bill in full on the 20th when you receive it, those five extra days of interest accrued without a grace period would still be considered a carryover into the next billing cycle. To avoid trailing interest, pay your bill on the last day of the cycle using an automatic bank transfer.
Cash advances and other non-purchase transactions such as balance transfers may not follow the same rules as purchases and may accrue interest immediately. Read the terms and conditions of your credit card to find out how different types of transactions accrue interest and whether a grace period applies.
Lower interest rates dampen the effect of carrying a balance, but how can you achieve a better interest rate on your credit card without a significant change in credit score? Matt Schulz, Senior Industry Analyst at CreditCards.com, suggests a way to potentially get a better rate: ask for one. Credit card issuers are keenly aware of their competition, and if you are a customer with a good history and excellent alternative cards, you may be able to leverage a better rate. According to Schulz, surveys at CreditCards.com showed that "about 80% of people who asked to have a reduced APR from their credit card get it...only about one in four people ever ask."
Of course, there is one sure way to deal with credit card interest — never charge more than you can pay off at the end of the month. You control interest by using the grace period to avoid it entirely. Remember the advice of Leisa Peterson, Certified Financial Planner® and Money Coach at WealthClinic®, "It's really nice to be in the driver's seat when it comes to money."
This article was provided by our partners at moneytips.com.
To Read More From MoneyTips:
3 Ways To Lower Credit Card Interest
Got Debt? Lower Your Interest Payments For Free
How To Boost Your Credit Score Fast
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