Understanding Credit Card Interest Rates (How They Work And How To Avoid Paying Them)

A credit card, in essence, is a tool to access borrowed funds – money you don’t own but can utilize for various financial transactions. So, what’s the cost? Similar to other forms of borrowing such as personal loans or mortgages, using a credit card comes with a charge, commonly known as interest in the finance world. Comprehending how credit card interest rates work can empower us to make informed decisions, avoid unnecessary debt, and ultimately, save money.

When you sign up for a new credit card, you’re assigned an Annual Percentage Rate (APR), the annual rate charged for borrowing, which varies from one card to another. This rate can range anywhere from 10% to as high as 30%, according to the data from the Federal Reserve [source](https://www.federalreserve.gov/releases/g19/current/). Your rate is generally determined by your credit rating, the better your score, the lower your APR.

The interest on your credit card is computed on a daily basis. It’s essential to understand this as different credit cards calculate interest rates in unique ways, which can impact your overall costs. The APR is divided by 365 to get the daily periodical rate, then it’s applied to the outstanding balance each day, adding up over time if you don’t clear the full balance.

Comparing credit card interest to other lending methods, credit card borrowing is probably the costliest way to borrow money, particularly if you’re only meeting minimum payment requirements. This is not only due to the high-interest rates but also because of the compounding effect, which means you’re essentially paying interest on interest.

This leads us to the crucial recommendation: You should aim at all costs to pay your full balance each month before the due date. If you can’t clear your full balance, at least aim to pay more than the minimum payment – doing so could save you a considerable amount in interest over time.

Unexpected expenses do occur. Having an emergency fund in place can save you from resorting to expensive credit card borrowing during those times. Think of an emergency fund as an interest-free loan to yourself. It’s recommended that your emergency fund should cover three to six months’ worth of living expenses. [source](https://www.investopedia.com/personal-finance/why-you-need-emergency-fund/)

Undeniably, the best way to minimize credit card interest is to avoid them altogether by paying your balance in full and on time. However, by understanding how credit card interest works and using this knowledge, we can still make credit cards a useful tool without the burden of high-interest costs. Remember, with knowledge comes power – the power to make informed financial decisions. Cooking the books, brilliant economist Alfred Marshall once said, “Money is our servant, not our master”. This couldn’t be more accurate in the world of credit cards.