How Does a Credit Card Interest Work?

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  | Published: 08 December 2020 | Last Updated On: 23 December 2020

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Ironically enough, understanding how credit cards works is both simple and hard at the same time. They convenience they offer, make them extremely easy to use. Just one swipe is all you need to complete your purchase. However, understanding how the credit card interest rate is applied on your purchases can sometimes be a tough nut to crack. It leaves people bewildered and confused. Therefore, a credit card can be both a curse as well as a boon.

If you don’t like carrying cash around, a single credit card can solve your problem. You can shop and later pay it off. If you have a rewards card however, it’s an even sweeter deal! You can collect the points, offers or cashback and enjoy the many fold benefits of using credit cards. However, if you have balance, paying off your credit card debt can take slightly longer due to the interest rate charged by credit card providers.

The interest rates on credit cards, popularly also known as finance charges will depend on your credit card company. Apart from that, the interest rate can also vary depending on which card from the same provider you own. Thus, interest rates are a big part of the rosy picture of credit cards and one must therefore be aware of the interest rate applicable on their card and how it is calculated. 

What is a Credit Card Interest?

Every purchase you make using your credit cards is subjected to an interest rate known as the Annual percentage Rate (APR). It the fees for allowing you to borrow money to spend, from the credit card provider. This interest is charged on the amount that you owe at the end of each month. If you are carrying a balance, it will incur extra charges.

Some credit cards however, charge a variable rate of interest that changes according to the prime rate. So, make sure to carefully read the fine print. If the prime rate increases, so will the credit card rate.

An important thing to note here is that you won’t be charged a dime if you pay your complete credit card bills on time. Interest rate on credit cards in UAE are charged only if you are late in your payment or if you have outstanding balance. So, there is no need to shy away from getting a credit card in UAE.

How does it work?

The rate of interest charged on your credit card purchases at the end of each month is mentioned in APR or the annual percentage rate in the bill. The credit card provider applies the interest rate on your account on the basis of the daily rate. This daily rate is your interest rate divided by the number of days in a year, i.e., 365. This daily figure is then used by the company to multiply it to your balance at the end of each day during an entire billing cycle.

For instance, a customer might spend AED 1000 to make purchases using their credit card in the UAE. However, this amount is not spent on a single day. It is rather spent in parts, spread across the entire period of a month. As a result, the net balance on the card will vary in accordance with the expenditure. This is a confusing process. So, based on the total amount that is owed to the company, it is spread throughout the month to calculate the average daily balance or the ADB.

Mathematically, the ADB can be calculated using the below mentioned formula:

ADB= The given balance x number of days the balance is carried forward / number of days in the given month

Every transaction is charged with the ABD and by the end of the month all the daily balance scores are added to arrive at the final rate of interest that is charged on any credit card in the UAE. 

How to know what is a good interest rate on credit cards?

It is difficult to ascertain what exactly is a good rate of interest that customers should be looking at while applying for a credit card. The interest rate will depend on a number of factors including the credit card company as well as your credit score. Those with an excellent credit score are able to get the best rates in the market as the lenders assume that there is less risk involved.

On the contrary, those with a bad credit score or no credit history at all will have a hard time getting lower rates of interest. They usually qualify for high rates of interest, sometimes even double as compared to the people with good credit history.

Thus, make sure to maintain a good credit score in order to avail the benefits of lower rates.

What is the best time to pay?

Let us tell you a little secret about credit card rates. Most companies that provide credit cards, offer a grace period. This grace period could be anywhere between 15 to 20 days from the day your billing cycle ends. During this period, you won’t be charged any interest if you are someone who regularly pays their due payments at the end of each month.

But if the cardholder is unable to pay the whole statement balance, or does not make the payments in time, this grace period is forfeited. Therefore, it is all the more important to read the fine print when applying for a credit card. 

In a Nutshell

Having an outstanding balance on your credit cards will cost you dearly. Thus, it is wise to be regular with your repayment schedule. Don’t let these astronomically high interest rate charges scare you from getting a credit card however. If you are unsure, you can also try applying for a balance transfer card to free your mind of any stress of incurring debt.