Personal Finance

6 min read

July 24, 2020

What are Purchase Interest Charges on Credit Cards?

The true (and hidden) costs of credit cards

In June 2018, a survey by Statista revealed that 83% of Americans between 30 and 49 years owned a credit card. And, with more than 1,123 million credit cards in the U.S., that’s a lot of buying power. If not handled wisely, it can also mean a lot of debt and financial hardship in the form of purchase interest charges.

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What are purchase interest charges?

When you make purchases on your credit card but don’t pay your balance in full every month, you rack up interest charges, which is listed as annual percentage rate or APR in your credit card disclosure. Banks and credit unions refer to this interest as purchase interest charges.

Purchase interest charges are based on the total balance on your credit card and the card’s interest rate–both of which can rise and fall from one month to the next. Be aware, you can be charged interest on cash advances, balance transfers, and all purchases you make on your card.

Some credit card companies offer an introductory, interest-free period when you open your card. However, once that period is over, you’ll be charged interest. So, to avoid purchase interest charges, it’s best to pay off your balance in full, if possible.

Why do credit card companies charge interest?

Credit cards are basically unsecured loans. The exception is a secured credit card that allows people with no credit to get a card by paying a security deposit upfront. With a car loan, a bank has collateral (your car) to take back if you don’t make your loan payments. With a credit card, there is nothing to take back if you don’t make your payments.

Your credit score will likely suffer, but the bank is left hanging with a loss. They can’t repo that luxurious vacation you paid for with your credit card. That’s why credit card companies, banks, and credit unions charge interest – to subsidize the risk of issuing you credit.

How do credit card companies calculate interest?

There are times when you get your credit card bill, only to find that you’ve been hit with a purchase interest charge even though you paid the full amount due on your last month’s bill. That’s due to how banks and credit unions, and credit card companies calculate interest.

Interest is accrued daily.  That means credit card companies calculate finance charges every day and apply that daily rate times your outstanding balance. The daily interest is then added to the balance on your card, so the next day the interest amount is a little more.

How can you avoid purchase interest charges?

The best way to avoid purchase interest charges is to pay off the balance on your credit card at the end of every billing cycle. Other ways to avoid paying interest include:

Opening a 0% interest credit card

Many credit cards come with a limited time 0% interest offer. The offer can range from a few months to more than a year of no interest. Unfortunately, there is a downside to these offers.  For instance. You purchased your $3,500 computer on a credit card offering 12-months, 0% interest on all charges. You pay the minimum payment of $25.00 every month. On month 12, you notice you are charged interest on $3,500, even though you have paid more than $275 in minimum payments for a year.

You, as the cardholder, must read the promotional offer on your statement and make sure that you pay off the balance in full before the end of the promotion or you may be charged interest on the original balance.

Consider a balance transfer

Some cards only offer 0% interest promotions on balance transfers, but not on purchases or cash advances. By transferring an existing balance to a 0% interest card, you have the opportunity to get your debt under control with zero added interest. But, if you take advantage of 0% interest promotions on balance transfers, be sure not to rack up additional charges that you can’t pay back by the end of the promotional period, or you’ll end up with high debt on your new card also.

Pay off your total balance due every month

The best way to avoid paying purchase interest charges is to simply pay off the total balance on your card by the end of the billing cycle when you made your purchases. The best way to ensure that you can pay off your balance is to avoid making purchases that are way outside of your budget. Sometimes an emergency arises, and you have no choice but to put a large expenditure on your credit card. When this happens, try to pay as much as you can every month and pay off your balance as soon as possible.

Keep in mind that credit card companies can raise your interest rate if you default on your terms and your payment is more than 60 days past due, your promotional period expires, or the index rate increases. But they must notify you beforehand.

Are you charged interest if you make minimum payments every month?

In a word, yes. Banks typically give a 25-day period from when a purchase was made to when the minimum payment is due. Any balance left beyond that period will be charged interest in the form of a finance charge.  But when a credit card company finalizes your statement, the amount owed is the balance on the statement date and it doesn’t include any new charges.

So, even if you pay your balance due in full on the due date, the balance has accrued daily interest every day for 25 days. Your next statement will show the interest your credit card company charged for the period from the statement date to the day your payment was received by the credit card company.

Some credit card companies calculate finance charges on the balance at the beginning of your billing cycle, the balance at the end of your billing cycle, or on your average daily credit card balance.

Bottom line

In the U.S. alone, nearly 70% of all people have at least one credit card. There are 1.06 billion credit cards in use in the U.S., and 2.8 billion cards in use worldwide, according to Shift Processing. No wonder credit card debt in the U.S. alone amounted to nearly 890 billion in the first quarter of 2020.

That amount of debt can add up to high purchase interest charges for millions of people every year. A good way to avoid paying interest is to pay off the total balance on your credit card by the due date. It’s also important not to overspend in the first place.

Sometimes the best answer is to simply use your credit card wisely, so purchase interest charges don’t add up and saddle you with even more unwanted debt.

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Kathryn Pomroy
Kathryn Pomroy is a journalist and writer specializing in personal finance, consumer banking, credit cards, and loans. She has written for LendingTree, Money Crashers, Quickbooks/Intuit and Bankrate.

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