As of early 2024, more than 13 million credit cards are in circulation in Australia. It’s one of the most popular forms of borrowing, which might seem confusing considering rates are typically signifcantly higher than you might expect to pay on a personal loan, for example.
Interest on credit cards can be a bit more complicated, with a few different rates involved - and if you pay off your bill within the ‘interest free period’, you might not need to pay any interest at all! Here’s how credit card interest rates work, and some of the ways to minimise your interest bill.
See Also: Credit Card Repayment Calculator
What is the purchase rate on a credit card?
The purchase rate is the interest rate that applies to most purchases you’ll make on your card.
A credit card is basically a line of credit you can use up until you hit the limit. Every time you don’t repay what you spend within your lender's ‘interest free' period, you’ll be charged interest on the outstanding balance, at the purchase rate.
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A typical interest-free period ranges between 44 and 55 days, but some credit cards might have a shorter or longer period. Once the period is up, any outstanding amount owed starts to accrue interest.
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Importantly, this means that you don’t have 55 days from each purchase to make a repayment. If for example, you bought a fridge on day 25, you then only have 30 days to repay this amount until you will be charged interest.
Interest free periods typically consist of a statement period (usually 30 days), then a following grace period to pay off purchases made during the statement period (the rest of the interest free period). Interest starts to be calculated as soon as a purchase is made, but provided the balance is paid off in full before the due date, it is not charged.
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How is interest calculated on a credit card?
Like most loans, interest on a credit card is calculated daily by multiplying the outstanding amount owed by the per annum (annual) purchase rate, then dividing this by 365. As soon as the purchase is made, interest begins to accumulate, but it is not charged until the interest free period has been exceeded.
Credit Card Interest Example
To explain this a little better for you, here’s an example.
John Smith spends $2,000 on April 1, on his credit card interest rate with a purchase rate of 16% p.a. Statement periods are every 30 days, and his interest free period is 55 days.
By dividing 0.16 by 365 days, you get 0.000438, which is the equivalent daily interest rate John pays.
By the end of his statement period on April 30, John has accumulated $26.28 (0.000438 x $2,000 x 30 days) in interest. However, provided he repays the $2,000 off by May 25, he will not need to pay it.
Once he passes this deadline though, interest begins to be charged. Generally, once an interest free period has expired, any subsequent purchases are immediately charged interest.
If John still doesn’t pay by May 25, and spends another $1,000 on a fridge on the 26th, his daily interest bill will be calculated based on an outstanding balance of $3,000.
What are the other interest rates on credit cards?
When comparing credit cards, you might notice other rates different from purchase rate.
Annual Percentage Rate (APR)
Often used interchangeably with purchase rate, APR refers to the annual cost for using the credit card. It differs from the purchase rate in that it also includes fees and other associated costs, so it’s a more complete picture of total cost. It’s similar to the comparison rate lenders have to show alongside the nominal interest rate on home and car loans.
Introductory rate
Some credit cards offer a temporarily lower ‘introductory’ rate to entice new customers. This might be as low as 0%, and can last for anything from about 6 months to 2 years. Once this period is up, the rate reverts to the standard purchase rate.
Balance transfer rate
Similarly, some providers offer temporary low, even 0%, rates for ‘balance transfers’, where a customer with an outstanding balance with one lender transfers it to another. The new lender essentially pays off the existing loan, then the customer repays them. If the customer repays in full during the balance transfer period, they are then charged interest at the far lower balance transfer rate.
Balance transfers might have lower rates but there are typically fees for transferring your balance over, usually 1-2%. So if you had a $2,000 balance, you would pay $20 to $40. In some special offer scenarios these fees might be waived as well.
Revert rate
If there is still an outstanding balance when the balance transfer or introductory period expires, it might move to a revert rate, often called the variable cash advance rate. This is often higher than normal purchase rates, so if you’re considering a balance transfer, it’s important to make sure to repay it all in time.
Cash advance rate
Unlike normal purchases, there tends to be no interest free period for withdrawing cash using a credit card. Interest begins to accumulate immediately, until the amount borrowed is paid back, at the cash advance rate, which is typically higher than the purchase rate.
If you’re withdrawing money via your credit card, you’ll want to be paying it back as soon as possible.
How to reduce paying interest on a credit card
There are few ways to minimise or avoid paying interest on your purchases.
1. Stick to the interest-free period
The only way to avoid paying any interest is to pay off your purchases during the ‘interest-free’ period. You’ll still have to pay any account fees for maintaining the card, however.
2. Pay off more than the minimum repayment
To reduce the amount of interest paid, consider paying off more than the minimum repayment by the due date. This will also help reduce the amount of money owed on the card and, in turn, will help you pay off the debt sooner. If you stick to the minimum repayment, a simple $100 purchase could balloon out in total cost and take a long time to pay off.
3. Stick to a repayment schedule and spend within your means
To remember your due dates, consider setting calendar reminders each month or, if your provider allows it, set up a direct debit to avoid the hassle of remembering.
Credit cards can be useful tools for people looking to take advantage of rewards programs and for other perks like purchase protection, and travel benefits. They can also help you make the most of your budget, without missing out on anything in life. However, the interest you pay for not repaying off your bill can be steep.
