A credit card’s interest rate is one of the most common financial features to research and compare, and for good reason. There can be significant variations between interest rates on different cards, as well as the number of interest-free days attached to a card, and that can end up costing the cardholder money.
What is credit card interest?
The premise of a credit card is that the purchases you make on the card are actually funds borrowed from the bank or financial institution, until the amount is paid off in full. The institution then applies an interest rate percentage figure to any dollar amount that is not paid off in full by the agreed amount of time set out by the card provider.
The interest amount on top of the amount owed is known as credit card interest.
Interest-free periods - how they work
You will regularly see attached to a credit card a number of interest-free days you have to pay off the amount you have spent in a statement issued to you each billing cycle. For example, if you have a 55-day interest-free period, that means you have 55 days from the day the statement was issued to pay the purchase amount due to the card provider.
Failure to pay
If you fail to pay the full amount off during that time, the card’s interest rate will be applied to the amount due as an extra payment.
Interest-free periods and billing cycles
The interest-free period you have may not correspond to your billing cycle.
Many card providers issue statements each month, while offering 55-day interest-free periods. This means your interest free period may end during the next billing cycle. You need to be aware of when the interest-free period finishes in your next billing cycle.
Being smart about your interest-free days
Interest-free days provide flexibility with purchases so that you can purchase something early in your billing cycle and then have the remainder of your 55-day period to pay back the purchase amount.
There are several ways to maximise the benefit of having interest-free days
- Purchase as early as you can in the billing cycle. This allows you more time to pay the amount off within the interest free period. If, for example, you purchase something on day 40 of a 55-day billing cycle, it means you have only 15 days left to make the full payment. Whereas if you made the purchase on day one, you would have the full 55 days to pay the amount off before interest was applied.
- Understand interest-free days apply only to eligible purchases. The definition of the term ‘eligible purchases’ varies slightly between different banks and financial institutions, but usually refers to everyday spending. This means other transactions will not necessarily be covered, so check with your card provider about their policy.
- You can lose your interest-free period. If you don’t pay the full amount due by your interest-free period, or only pay the minimum amount, you will lose your interest-free period until the full amount is paid in the next billing cycle. Your interest-free period will then be reinstated.
Looking beyond interest-free days
When you’re looking at the interest-free period, you also need to look at the card’s interest rate, annual fee and other features. You need to take into consideration:
- Some interest rates can exceed 20 per cent, so compare what different card providers are offering as this can make a substantial difference if you don’t meet your interest-free period obligations.
- There may be a $0 annual fee for the first year with the card, but you also need to look at what the annual fee reverts to after that year.
- Examine what the charges are on any balance transfers made when you first get the card as well as after any special introductory periods.
- Investigate whether cards with similar interest free-periods also have a rewards program attached to them that may suit your needs.
- Finally, you need to realistically appraise your spending habits and determine whether the credit card has everything you require.
If you’re disciplined with money and are working towards clearly defined financial goals, a credit card can be a valuable tool in assisting you to achieve those goals. But if you’re looking at credit cards as a quick fix solution to a problem situation, you need to look at other more effective options.