How is credit card Interest calculated?

This article talks about how credit card interest is calculated, when it is charged, and other important points related to it.

· 4 min read
How is credit card Interest calculated?

Credit cards allow customers to avail short-term credit while entering in transactions. It is an attractive payment instrument and is considered a safe and highly rewarding option than other forms of payment. Credit cards are often considered as a loose debt and thus steeper interest rates compared to other loans are levied on them. Credit card interest rate is known as finance charges, and it varies from one card issuer to another or may also vary for different cards issued by the same issuer. Since credit cards are generally used to finance day-to-day expenses, it might slip from the mind of the customer that all purchases made by him are paid with interest, which shall accrue from the day he bought the items. It is highly advisable that before getting any credit card, the holder should be aware of the interest rate charged on them. Although, credit card interest rate calculation is a little complex process but is also significant to know about the damage to your financial well-being that a delayed payment on credit cards can do.

Credit Card Interest Calculation

Credit card interest rates are not linked to factors such as the user’s credit score and repayment capacity like any other loan. Usually, all credit card issuers have preset finance charges that remain fixed for all their customers. The calculation of interest also depends on the type of transaction undertaken by the cardholder. There can be two forms of the transaction using a credit card:

  • Cash Advances: Cash advances are said to occur when cardholder withdraws money from the ATM using their credit cards. Interest calculation on such transactions is simple and clear as interest is simply calculated as per the stated interest rate from the date of withdrawal to the date of making the payment of the outstanding amount.
  • Regular Payments: Most frequently credit cards are used to make payments of day-to-day purchases and expenses such as online purchases, paying bills, and so on. The interest calculation on these transactions is a little tricky and complex. Under these transactions, customers get a free credit period, within which no interest is charged from them. But in the event of his failure to honor his payment commitment within the free credit period, interest shall be calculated and charged from the date of transaction for all the payments made thereafter till the outstanding payment on the card is discharged and paid off.

The interest on credit cards is calculated by the average daily balance method and finance charges are paid based on the monthly percentage interest rates. The simple formula used to calculate interest is:

Interest = (outstanding amount x monthly interest rate x 12) x number of days/365

When is Interest charged on credit cards?

Interest on a credit card is only applicable when any amount is outstanding in the holder’s account or when the cardholder withdraws any amount from the ATM using his credit card. The situations that may lead to an interest in credit cards are:

  • When the cardholder fails to make any payment at the end of the billing cycle.
  • When the cardholder pays any amount lower than the total outstanding amount.
  • When the cardholder makes only the minimum amount due.
  • When the cardholder withdraws any money from an ATM using his credit card.

Other Important Points

Grace Period: Grace period or free credit period refers to the period during which no interest is charged if the cardholder pays the outstanding amount in entirety for the monthly credit card bill. This concept of grace period is not applicable in case of cash advances i.e., interest shall be calculated from the date of cash withdrawal. Banks in India generally grant a grace period varying between 20 to 60 days.

Interest Rate: The interest rate charged on credit cards is known as the Annual Percentage Rate (APR). The monthly interest rate on credit cards normally is around 3.35-3.5%. Some popular banks in India also provide low monthly interest rates varying between 1.5-2.99%, although to access such low rate credit cards, one needs to fulfill certain conditions laid down by the bank. Some of the low-interest rate providing banks in India are SBI (SBI Advantage Platinum Credit Card), ICICI (ICICI Bank Instant Platinum Credit Card), HDFC (HDFC Infinia Credit Card), and so on.

Most Important Terms & Conditions (MITC): Each bank has the obligation to disclose the method of charging interest in its MITC document. The MITC document of every bank is available on their websites, and this document also forms the part of the welcome kit that the cardholder gets on the issuance of a new credit card.

Other Charges on Credit cards: Apart from the interest rate charged on the credit cards, several other charges are levied on credit cards. These include the following:

  • Annual Maintenance Fees: These are charged once a year and are thus known as annual fees. Banks may also offer free credit cards so that there are no joining or annual fees on the card for a lifetime or for a certain specified time period.
  • Over-Limit Fees:  Banks may or may not allow cardholders to spend over the limit specified by them. Even if banks allow it, they charge heavy fees on such transactions.
  • Late Payment Fees: In case the cardholder fails to honor his credit card dues, the bank provides an option to pay the minimum amount. But if cardholders do not even pay this minimum amount, the bank will levy a late payment fee.
  • GST: All charges on the credit card attract GST at the rate of 18%.

Example

The following are some transactions that took place through Mr. Kumar’s credit card.

  Transactions Amount
A Purchased clothes on May 10, 2020. 20,000
B Total Amount Due on Statement dated May 15, 2020.  20,000
C No Payment on Due Date i.e., June 03, 2020. NIL
D Purchased headphones on June 07, 2020. 5,000
E Payment of credit card dues on June 10, 2020. 10,000
F Interest on 20,000 for 30 days (May 10 to June 09) at 40.20% p.a. 660.82
G Interest on 10,000 for 6 days (June 10 to June 15) at 40.20% p.a. 66.08
H Interest on 5,000 for 9 days (June 07 to June 15) at 40.20% p.a. 49.56
I Total Interest in the Statement dated June 15, 2020 (F + G + H) 776.46
J Late Payment Fees 600
K Goods & Services Tax @ 18% on I & J 247.76
L Total Principal Outstanding (A + D – E) 15,000
M Total Due as per Statement dated June 15, 2020 (I + J + K + L) 16,624.22

Please note that the Interest Rate and Late Payment Fees are taken hypothetically and may differ from bank to bank.

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