Understand how credit card repayments work and reduce your interest costs.
Credit card interest repayments can be tricky to get your head around, with different fees and clauses attached to every account. While these details are all finely printed on product disclosure statements, many of us don’t read these closely or don’t understand how interest rates really work.
Unfortunately, a lack of understanding can result in debt. While most people use their credit cards with the intention of paying off their debt in the short term, sometimes this becomes difficult to manage. Others simply make monthly minimum repayments without realising the negative impact this makes on their long-term finances. No matter who you are and what your spending habits might be, understanding how interest affects your bottom line will help improve your level of control over your money.
How much is the minimum credit card repayment?
The minimum credit card repayment is usually $25 or 2.5% of the closing balance, whichever is greater. The percentage of the total balance required or minimum amount required varies depending on the bank.
How do credit card minimum repayments work?
Credit card companies allow you to carry an outstanding balance as long as you make the minimum repayments stipulated on your monthly bills. The way your minimum repayment amount is calculated may vary between card providers, but it is commonly calculated as the higher of a percentage of your closing balance (usually 2-3%), or a minimum dollar amount (e.g. $10 or $25).
If you were to make only the minimum repayment amount each month, your cost of interest would easily and most definitely exceed your original loan amount over time. For example, if you had $5,000 owing on a credit card at an interest rate of 18%, you’d end up paying $17,181 over 33 years if you made only 2% minimum repayments each month. That’s assuming there were no other transactions made on the card and no annual fees or other charges that would add to this cost and time. Conversely, you could pay off the same debt in 2 years if you paid $246 each month. You would pay a total of $5,902 and save $11,279 in interest fees!
The different types of interest you might be charged
A breakdown of the different types of interest charges will help make this clearer:
- Purchase interest. This is the most common type of interest charged when you make a purchase, and this type of interest enjoys the interest-free period that most cards offer. Depending on the card, this could be 0% for a promotional offer and up to 12% to 20% for a standard rate.
- Cash advance interest. This is a higher interest rate that is charged when you make ATM withdrawals or cash equivalent transactions like buying traveller’s cheques or gambling. This type of interest usually does not enjoy any interest-free days and therefore accrues interest immediately. Cash advances usually accrue higher interest than purchases and can sit around 20% to 22%.
- Balance transfer interest. This is the interest on your balance transfer amount which typically attracts the same rate as either your purchases or cash advances. However, credit cards often offer special or introductory balance transfer promotions that involve you paying 0% interest for an initial period, e.g. 6 months or 12 months, etc. The rate will revert to its usual after that introductory period is over, which could be either the purchase rate or cash advance rate.
- Interest on fees. Interest accrues on your credit card fees too, like the annual fee or late fee for instance. While this means they could collect interest, it also means that they could be eligible for interest-free days if you pay them in full.
How to allocate repayments with a 0% balance transfer credit card
Keith has a small balance transfer debt of $2,000 on his credit card with an introductory balance transfer rate of 0% for 10 months. He then uses his card to buy a TV set for $500, to which a standard purchase rate of 19.99% p.a. is applied. If he makes monthly repayments of $200, his repayment amount will be used to pay down the TV set first, since it’s attracting the higher interest rate.
In the third month, when he has completely paid off the purchase balance of $500 plus interest (about $25), the remainder of his repayment ($75 for that month) will be allocated to the balance transfer. By the 10th month, Keith would have paid down $1,475 of his $2,000 balance transfer debt.
However, now that the introductory period is over, interest will start accruing at the purchase rate of 21.99% on his $525 balance from the 11th month onward. If Keith continues to make $200 monthly repayments, he will pay off his balance in 3 months and pay a total of $33 in interest.
How are credit card repayments allocated?
Since the introduction of the “National Consumer Credit Protection Amendment (Home Loans and Credit Cards) Bill 2011”, the way that credit card companies allocate your repayment amount has changed. Accounts approved before 1 July 2012 were subject to the card provider’s own hierarchy of payments (where your repayment usually paid off interest fees and purchase transactions before higher interest transactions like cash advances). However, accounts approved after the credit card reform took effect in July 2012 now require the balance that attracts the highest interest rate to be paid first, followed by the part with the next highest interest rate and so on until all interest charges have been paid.
Tips for managing credit card repayments
- Pay the full balance. If you can, paying the full balance each month will eliminate the pesky issue of interest entirely. This allows you to fully enjoy the advantages of having a credit card, its convenience and rewards, while ruling out the possibility of mounting interest altogether.
- Always pay more than the minimum. If you can’t pay the full balance, paying more than the minimum amount will help you save a great deal of money on interest charges in the long run.
- Set up auto payments. Setting up automatic debits from your savings or transaction account can go a long way in helping you manage your credit card debt. It might be a good idea to set it up to take place on the same day you get paid so that you don’t spend the money elsewhere.
- Consider credit card insurance. This type of insurance will take care of your debt if you lose your job or can’t work due to sickness, injury or death.
Now that you understand how your interest fees and credit card repayments work, you can be more mindful about how much to repay each month. That means you can work towards being debt-free and staying that way.Back to top