Why do credit cards charge interest?
Monday, 10 June 2019
It's easy to think of a credit card as just a convenient way to make purchases.
But in reality, when you use a credit card, you're borrowing money. You're taking out a short-term loan. And with most loans — like an auto loan or a mortgage — you pay interest when you borrow someone else's money to make a purchase. A credit card is no different.
However, unlike auto loans or mortgages, there is a way you can enjoy all the benefits credit cards offer without paying interest: by paying your balance off each month.
First, here's how credit cards work
A credit card is a line of credit you can use to make purchases up to your credit limit. Each month you receive a statement that shows what purchases you made and your account balance — or how much you owe. In most cases, you will have somewhere between 25 and 31 days from the date of your statement to make a payment.
Almost all credit cards give you the option of making a minimum monthly payment, which is typically a small percentage of your total balance. In order to keep your card active, avoid penalties and fees, and protect your credit score, you typically must make at least the minimum payment each billing cycle.
Now let's talk about credit card interest
If you only make the minimum payment, or any amount less than your total balance, you will be charged interest on the unpaid amount.
As mentioned, you typically have between 25 and 31 days from the billing cycle to make a payment. During this time, you may not be charged interest on new purchases if you pay your entire statement balance in full by the due date. This is often referred to as a “grace period." In these instances, if you always pay your entire statement balance by the due date, you may avoid paying interest on purchases (but not Cash Advances or Balance Transfers).
The interest rate you pay is based on several factors
Interest rates vary from card to card, but because credit cards are unsecured loans — which means they are not backed by collateral like auto and home loans — interest rates on credit cards are typically higher than rates on secured loans.
The interest rate on your card will be based on several factors, such as the current interest rate environment. Another very important factor is your credit score. In most cases, people with good credit can get a lower rate on a credit card than someone with a lower credit score.
According to a survey by wallethub.com, in 2018, applicants with excellent credit received rates in the 14% APR range while rates for those with fair credit were 22% APR and higher. And even at 14% APR, it's easy to rack up some significant interest charges in a short period of time if you don't pay off your balance each month.
What if you can't pay off your balance each month?
Everyone has emergencies or unforeseen expenses, and that's when a credit card can be a lifesaver. But having to make large, unexpected charges can also make it difficult to pay your balance off during the grace period. However, if you shop around for a card with the lowest possible interest rate, you can still enjoy the maximum convenience credit cards offer while paying a minimal amount of interest.
The content provided is for informational purposes only. Neither BBVA USA, nor any of its affiliates, is providing legal, tax, or investment advice. You should consult your legal, tax, or financial consultant about your personal situation. Opinions expressed are those of the author(s) and do not necessarily represent the opinions of BBVA USA or any of its affiliates.
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