When you use a credit card, you're borrowing money from your account's credit limit. So just like any other loan, interest may be charged on the balance. How and when this interest is charged will have a big impact on what you'll pay to use your card. You can compare low interest credit cards at the bottom of this page.
Interest rates are a type of fee that's charged when you borrow money. Meaning when you pay back what you owe, you actually end up paying more than what you've borrowed. With credit cards, interest rates are calculated as a percentage of your balance and shown as an annual or per annum figure. For example, a card could have an interest rate of 9.99% p.a. (per annum) or 21.99% p.a.
Most credit cards also charge different interest rates for different types of transactions, with the most common being a rate for purchases and a different, usually higher, rate for cash advances.
How is credit card interest calculated?
The interest rate on credit cards is normally shown as an annual figure. But most credit card companies calculate interest on a daily basis and then add the charges to your account at the end of each statement period (month). To figure out your credit card interest charges, the amount you owe is multiplied by the daily interest rate on your credit card. These daily calculations are then added together at the end of the statement period to get the total interest due.
Compound interest costs
The way credit card interest is charged is known as "compound interest" meaning that you could end up paying interest on your previous interest charges. The good news is that you can cut down on interest costs any time you make a repayment, because that will also affect the daily interest calculation.
Here are the most common types of interest rates you'll find on credit cards:
- Purchase interest rate. This is the interest you are charged when you use your credit card for making regular purchases and payments in retail outlets or online.
- Cash advance interest rate. You'll be charged the cash advance rate when you use your credit card for withdrawing cash from ATMs or cash equivalent transactions, like buying gift cards.
- Balance transfer interest rate. The balance transfer interest rate is charged when transferring an existing credit card debt to a new card.
- Promotional interest rate. Many credit card companies offer new customers a promotional interest rate for purchases and/or balance transfers. This promotional interest rate is only available for a limited time, with the standard interest rate applying after that. For example, a card may offer you 0% interest on balance transfers for the first 12 months. If you didn't pay off the balance transfer during the first 12 months, the standard rate for balance transfers would apply to the debt.
Even the smallest difference in credit card interest rates can have a huge impact on your account costs. So when you're looking for a new card, make sure you compare both the standard and promotional interest rates to help you find one that suits your needs.
How to compare credit card interest rates
To show you how important it is to compare interest rates, let’s say you have a balance of $1,000 on a credit card with an interest rate of 20.99% p.a. If you only made monthly payments of $50 on this debt, it would take you around 2 years and to pay off your balance and cost you about $212 in interest.
On a credit card with an interest rate of 15.99% p.a., it would still take around 2 years to pay off your balance but would cost you $153 in interest. That’s a saving of $59 compared to the card with a higher rate, which is basically another monthly repayment. The bigger the difference in rates, the greater these potential savings would be.
You can use this calculator to figure out how much you're paying on your current card, how much you could save with a low rate card, or how to plan your repayments and save yourself the most money.
*Whilst every effort has been made to ensure the accuracy of this calculator, the results should only be used as an indication. They are neither a recommendation nor an eligibility test for any product and should not be construed as financial advice, investment advice or any other sort of advice.
The simple answer is that your repayments will go towards the balance attracting the highest interest first. Anything remaining will go towards the next highest interest balance, and so on down the list.
If you only have one interest rate for your entire balance (say, if you've only used it for purchases), you can use our calculator to figure out how long it would take you to pay off your credit card debt for a given monthly repayment.
Example: Payment allocation with a balance transfer
|Cash advance (21.99% p.a.)|
|Coffee machine purchase (17.99% p.a.)|
|Balance transfer (promotional 0% p.a.)|
As you can see, the repayments have gone to the highest interest parts of the debt first. This leaves you with $500 owing after three repayments.
In this example, we've assumed your introductory balance transfer rate applies for the entire time. But if the 0% balance transfer rate ended after the first repayment and went to, say, 21.99% p.a., it would be paid off before the coffee machine purchase.
Watch out: Making purchases with an active balance transfer
The payment hierarchy almost always means you'll owe less money in the long run. The main exception is when it comes to introductory rates on balance transfers.Your introductory 0% interest rate means repayments will always go towards purchases first since they will be charged interest.
But once the introductory period ends, you could be left with a large balance that attracts higher interest than any purchases.This means it is important to avoid purchases until you've paid off your balance transfer if possible. Otherwise, see our guide for tips on managing purchases on balance transfer cards.
A brief background on credit card payment allocation
The current payment hierarchy system has been in place since 1 July 2012, following credit card reforms. Previously, repayments would go towards the most recent transaction instead of the highest interest balance.
Two other important reforms were introduced at the same time:
- A ban on over-limit fees, unless you agree to them
- A notification when you go over your credit limit
For more info on credit card reforms, see this page. If you want to learn more about making repayments, this guide takes you through the process. You can also use the repayment calculator to work out a payment plan or look at cards that offer instalment plans with fixed repayment options.
As well as interest rates, make sure you consider the following when you're looking for a new credit card:
- Interest-free days. Many credit cards offer up to a certain number of interest-free days on purchases when you pay your account balance in full by the due date on your statement. For example, up to 55 days interest-free. This gives you a way to avoid interest charges for spending on your credit card.
- Annual fee. Most credit cards charge an annual fee, which could also add to your account balance. Remember to factor this cost in when your comparing credit cards and also when you're budgeting for interest costs and repayments.
- Other features. Many credit cards offer complimentary extras such as insurance or rewards, which could help offset the cost of the annual fee and interest charges. Just remember to weigh the value of the benefits against potential costs so you can decide if a card is worth it based on your spending habits and goals.
If you're looking for a new credit card, you can use our tables to compare your options based on interest rates. Just click on the "Purchase rate" or "Balance transfer rate" column and the table will update to show you cards with the lowest to highest rates.
When applying for a credit card, it’s important that you read the fine print to understand all the terms and conditions of your agreement. This way you're prepared to use your credit card in a way that benefits you the most.
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What does APR mean?
APR is the acronym for Annual Percentage Rate, which is the standard way of expressing the cost of credit as an annual percentage.
What is an interest charge?
An interest charge refers to the interest fee you'll have to pay on your credit card account. This can be in the form of a purchase interest rate, cash advance interest rate or balance transfer interest rate and is calculated as a percentage of what you owe.
How do I get a competitive interest rate?
Compare your options. Use the table on this page to see Finder's selection of low rate credit cards, check out some reviews and find the right deal for you. If you've already got a credit card and you're paying too much interest, consider a balance transfer credit card.