Since the number of credit card holders in the U.S grows every year, it’s likely that you own a credit card account too. After all, it’s so easy and convenient to use! Just swipe here and swipe there, and you get to make big purchases that you couldn’t even dream of when you only had cash or a debit card. Yet such spending comes with a price — usually in the form of purchase interest charge.
Essentially, if you’re not careful when using your credit card, you could rack up a hefty debt that is hard or impossible to pay off. This debt is often the consequence of snowballing interest charges, so I’d recommend you do your research on time to avoid this. To help you start, I’ve made a list of things you should know about purchase interest charge.
1. What Purchase Interest Charge Is
The convenient thing about credit cards is that you get a certain amount of money to spend each month. You don’t necessarily have to own this money — in a way, your bank is lending it to you to use it as you wish. As long as you don’t exceed your pre-set card limit, you can go on a spending spree.
But banks aren’t known for their generosity, so naturally, they expect you to pay the money back at the end of the month. If you don’t pay back in full, you will be charged an interest rate on your average daily balance and will end up paying more than you originally borrowed. This interest rate is exactly the purchase interest charge, and the best way to avoid it is to pay the whole bill at the end of each month.
2. Grace Period — What It Is and How to Make the Most of It
Most credit cards give you at least 21 days after the end of a billing cycle to pay your balance back. This period between the issuing of a credit card statement and a payment due date is called the grace period. While it lasts, no interest rates will be charged on your new purchases. If you pay off the whole sum, then you will be free of interest charges on purchases the next month as well.
However, if you leave even a single dollar in your unpaid balance, purchase interest charges will be applied immediately at the end of your grace period. Interest charges on that one dollar won’t be much, but they will also hit any new purchases you make that month. So depending on how much you spend, that one dollar could turn into $15–$20 during just one billing period.
A grace period is usually offered only to new customers, so start off your credit card use wisely by making the most of it. Pay off your balance in full right away and develop healthy spending habits. That way, you won’t find yourself riddled with debt.
3. How Your Purchase Interest Charge Is Calculated
Calculating your purchase interest charge isn’t easy, but it might be good to know the basics of how it’s done. Thus, if you end up accruing some debt, you will understand it better and you’ll know how to pay it off as painlessly as possible.
● Convert your annual percentage rate to daily rate. Annual percentage rate, or APR, is the interest rate that your bank charges for lending you money on a yearly basis. Since purchase interest charge is applied to your average daily balance, you need to calculate the daily rate. This is relatively easy — just divide your APR by 365. So if your APR is 14%, your daily percentage rate will be 0.038%.
● Calculate your average daily balance. Let’s say your billing cycle is 25 days long. You started the billing cycle with an unpaid balance of $500 from the previous month. On the 10th day, you buy a book for $20, and on the 20th day, you spend $30. That means that your daily balance for each day would look like this:
- Days 1–9: $500
- Days 10–19: $520
- Days 20–25: $550
Now, to calculate your average daily balance, add up all daily averages in one billing cycle. Then, divide the sum by the number of days in the cycle.This is what you would get with my example: [($500×9) + ($520×10) + ($550×6)]/25 days = $520. This number is your average daily balance.
● Calculate your purchase interest charge. Finally, multiply your daily rate by your average daily balance and then by the number of days in your billing cycle. The number you get is your purchase interest charge. In my example, we will get $4.94. However, keep in mind that your bank might use a different billing cycle and that due to compounding, this interest rate changes over time.
4. How Purchase Interest Charge Works
If banks only applied interest charges on the sum you haven’t paid in full, paying off debts would be easier. Sadly, that’s not the kind of world we live in, and you will be charged interest on the interest you haven’t paid.
For example, let’s say you have an unpaid balance of $1,000. Your APR is 14% like before, so you’ll have the same daily percentage rate of 0.038%. On the first day, you’ll be charged 38 cents, so your new unpaid balance will be $1,000.38. And on the second day, that new balance will be used as a base, and the unpaid interest will compound.
You can probably see how this could easily spiral out of control if you aren’t careful. That is why banks and lenders ask for a minimum payment each month. The minimum payment usually includes a percentage of the unpaid balance and the full amount of charged interest. I’d recommend paying the minimum payment in full each month to avoid accumulating unmanageable interest over time.
5. How to Manage Your Debt
With so many possible pitfalls, it’s very easy to end up trapped in the vicious cycle of interest rates and minimum payments. It may seem like no matter what you do, your bills at the end of the month are only getting higher. As it turns out, around 75% of other credit card users feel just like you.
But don’t despair just yet. With careful planning and responsible spending, you can start steadily paying off your credit card debt. Here I will show you some of the ways to do that:
Manage your budget
Your debt won’t disappear on its own, nor will you pay it off if you spend carelessly. Keep track of how much you earn and spend. You’ll become more aware of how much money you can put aside for paying off your credit card debt. On top of this, you’ll notice if there are ways to cut down on your spending, which will certainly help in the long-run.
Don’t pay only the minimum payment
The minimum payment is exactly that — a minimum amount that you must pay in order to stay afloat. But if your goal is eventually paying off your debt, covering only the minimum payment won’t be nearly enough. Instead, put aside some more money and pay double the amount of your minimum payment. Your debt will be smaller, so the purchase interest rates will go down as well.
Spread the payments throughout the month
There is no law that states you have to pay off your debt only at the end of the month. As it turns out, paying a few times per month will cost you less. How does that work?
Remember, the more you spend, the higher your purchase interest rates will be, but if you pay off a part of your debt, they will go down. Imagine the following scenario: your daily percentage rate is 0.038% and you have an unpaid debt of $500. At the end of the billing cycle, on the 25th day, you pay off $100. In this case, your average daily balance is $496 and your purchase interest charge is $4.71.
But what if you decide to pay off $50 on the 10th day, and another $50 on 25th day? Your average daily balance becomes $466 and this means that the purchase interest charge is lower too — $4.41. This is a decrease of almost seven percent! And if you pay in several more installments during the month, you will decrease the rate even further.
Limit your use of credit cards
As much as you love your credit cards, let’s face it — continuously using them when you can’t afford it isn’t the smartest move. Instead, I’d recommend setting a personal limit. For example, if your pre-set card limit is $2000 a month, don’t use up all that money. Instead, commit yourself to spending about a third of that budget — $600 in this case.
If you have debit cards, you can use them instead. That will limit your credit card use even further and bring down your purchase interest charge. And ultimately, that is your goal.
6. The Best Methods for Paying Off Your Debt
If you’ve applied the techniques for debt management, then good; you’re getting closer to regaining financial freedom. However, there are still a few more ways to tackle your debt. Here I will show you the three most effective methods, none of which is necessarily better, but all of which have some advantages:
If you’re using a few credit cards, and you have debt on all of them, don’t pay off the smallest balance first. Sure, it may seem intuitive to do so, but you’ll save more if you pay off the debt on the card with the highest interest rate.
This might take longer, as your high-interest rate card probably accrued the most debt over time. But by paying it off, you will simultaneously lower the purchase interest charge, so your total debt will not grow as fast as before. Tackling interests is the very purpose of the avalanche method.
On the other hand, the snowball method does exactly what is intuitive — it tackles the total debt rather than interests. When using this method, first you will deal with the card with the lowest balance, regardless of the interest. The idea is to deal with debt as quickly as possible, though you will save less than you would with the avalanche method.
So if you’re saving less, why should you use the snowball method? Well, it ultimately comes down to what kind of person you are. Some people simply find it more motivating to pay off small debts in full. As practical as the avalanche method is, the results aren’t immediately obvious, and not everyone has the willpower to persevere until they are.
Consolidate Your Cards
This method is simple but effective. If your debt is spread out across several credit cards, move all of it to the card with the best interest rate. Not only will you save a lot of money, but you’ll also keep track of your debt easily if it is all in one place.
The only way to deal with purchase interest charge is to understand what it is. Don’t let yourself get trapped in the same vicious cycle that has trapped so many others. Learn how to stay on top of your debt, or even better, how to avoid it altogether.