Wallet

How Much are You Giving to Your Credit Card Provider?!

This might come as a surprise to you but the way that the amount you are obligated to pay to your credit card provider is calculated is not as straightforward as you might think it is. Interest and charges are the two things that ensure the credit card provider earns money from doing business from you, and are actually quite free-flowing and dependent on a lot of elements.

To fully understand the full extent of what it means to be in debt, you have to understand just how much credit card providers are going to charge you for reach transaction you make.

Charges

Charges are different from interest and are typically applied if there is a late payment or if the outstanding amount goes over the limit. Unlike bank charges which might be slightly more lenient if the bank officer has looked over the account and decided a simple warning would suffice. With credit card companies it tends to be an automatic charge, typically around £12 a time.

When you start to get charges being applied to your account it really is a warning sign that the account is not being managed properly and now is the time to look at his directly to deal with it. The worst thing to do is ignore – the only person getting hurt is going to be YOU.

Interest

How are APRs Determined in the First Place?

A single person’s APR can be determined in several ways. For some card holders, single purchase APRs are sometimes used.

In most cases, especially for the sake of uniformity, issuers would look at a range to determine your APR. For many starting credit card holders, that range is from 20% to 30%. The APR also signifies your creditworthiness. The more trustworthy you are, the lower your APR is.

Lets not skate over these numbers. 30% APR means that if you regularly carry over debt month to month and then only pay back minimum payments it is going to take an awful long time to ever come out of this trap.

Making minimum payments means you pay the interest due but very little actual principal capital is paid back meaning the following month you are in the same boat having to repay any bunch of interest.

The type of credit card you applied for also influences the APR. Some credit cards like rewards cards and credit builder cards have higher APRs than most other cards.

Lastly, there is the factor of prime rates. These are the rates that banks issue to their biggest-spending customers. If the prime rate goes up, so will your APR.

The Truth About APRs

Your annual percentage rate or APR is what will determine how much you have to pay in interest, at least on paper. But let’s say that you have an APR of 15%. Does that mean that you only have to pay 15% in interest every year to one credit card? The answer is no.

Although APRs are expressed on a, well, annual basis, credit card providers actually have to charge you on a monthly basis. How do they do that? They use a three-step calculation process.

Step 1: Getting the Daily Rate

Since the APR is expressed on a yearly term, it needs to be broken down into days. To do that, credit card providers merely have to divide your APR by the number of days in a year or 365 (this is still the same amount even in a leap year). So, if your APR is 15%, then your daily rate is at 0.04%.

Some providers might use 360 but the difference is minimal to the point of being inconsequential. Either way, your daily interest rate is going to be somewhere in between 0.01% to 0.1% depending on the APR.

Step 2: Finding the Average Daily Balance

First, the credit card provider sets up a billing period. This usually covers a full month but rarely do providers use a calendar month. Simply put, it’s a 4-week period that always begins either with one day of the week and ends in the day before that 4 weeks later.

Then your unpaid balance will be determined. This is simply every amount you have unpaid in previous months carried over to the next billing cycle. Of course, that balance changes every time you make a payment (or miss one). To get the average daily balance, the provider will simply divide the balance by the number of days in the billing period.

Step 3: Putting Everything Together

The last step is to multiply the daily average balance by the daily rate. The result will then have to be multiplied by the number of days in the billing period. The end result will be your daily rate that the credit card provider has to charge you in every billing period, plus the amount you have due.

Why Daily Rates tend to be Higher than APRs

You might be surprised that the actual amount you have to pay is higher than what was calculated by the provider. This is because credit companies use a process called compounding when calculating your monthly rates. The process simply adds any accrued interest into your unpaid balance. Simply put, you are going to pay interest on interest.

For example, your daily balance at an average is £2,000.00 for the entire year. If your APR is at 15%, you’d expect to pay as much as £30.00 per month or £360.00 per year for interest. However, due to compounding, the actual amount you have to pay is your unpaid balance plus an interest of somewhere in between £390.00 and £480.00, depending on the issuer.

So, you could just imagine how quickly debt can get out of control if your APR is somewhere in between 20% to 30%. This has led to many credit holders to saying that it’s not the initial amount that’s going to put you in debt, it’s going to be the interest added to it.

Can Your APR be Lowered?

Short Answer? Yes. As was stated before, interest rates are determined by a number of factors and many of these factors are reliant on your actions. The most direct way you can lower your score is through your payments and you can do it in several ways.

1. Pay On Time – Not only does this give the impression to the issuer that you can handle your debts properly, it also means that you don’t have to deal with interest at all. Some issuers have grace periods for payments which means that you don’t have to pay for interest if you can pay your dues on or before the required date.
2. Pay More – If you can’t pay the bill in full, then at least pay more than what is required from you on a monthly basis. This way, the balance you have on every billing period gets lowered which can lower your daily balance rate and, ultimately, your interest rate.
3. Pay Often – Whenever possible try to attack your outstanding balance several times within the same billing period. This will drastically lower your balance which also lowers the interest. Plus, multiple payments get reported into your credit score which will increase it.

The Snowball Method

When it comes to dealing with debt, you might have always heard to deal with the biggest ones first. However, there are instances when this won’t work especially if you have only a limited period of time to clear all, if not most, of your debts.

This is where the snowball strategy of debt management can come into play. How it works is quite simple: First, you have to list every debt that you have. However, instead of listing them from the smallest to the biggest, you’d do it in reverse. This time, you are going to start from the small ones and work your way up.

The trick here is to always pay your smallest debts in full or, if not possible, then pay more than the minimum for each. As for your larger debts, you can always pay the minimum or above the minimum on a regular basis. Also, you must do this often, not missing a payment for each of your debt.

At the same time, you need to find extra money wherever you can. It doesn’t matter if its a second job or savings here and there. Every money you have should go into paying these debts. And when a debt is cleared, the money you have saved to pay for that should be rolled over to the next entry. Continue this payment scheme until you are free from most, if not all, of your debts.

The secret to the snowball method lies in its speed without sacrificing priorities. You are effectively dealing with multiple debts at once but it is done so in such a manner that you don’t feel overwhelmed by all of them.

Compare this to focusing on the bigger debts. You might spend more time dealing with multiple payments for a single debt when you could otherwise clear multiple entries on your list.

Of course, the key to success here is to be as constant as possible when making your payments. You should have enough money to pay for multiple debts on your list while also attending to your usual expenses. As such, having multiple sources of income might come in handy when using this debt management strategy.

In Conclusion

There are two reasons why interest rates are there when you apply for a credit card. First, the issuer still has to find ways to make the money you owe them increase. Next, they’d have to determine if you yourself are quite capable of handling debt.

That being said, however, it’s easy to lose track of what debts you have to pay if you’re not careful. An interest rate might start out as high but your ability to settle all of your financial obligations despite your APR will help a lot in reducing its effects. If your interest rates are not lowering as fast you want them, then at least you’d have develop sound financial management skills to the point that having a high APR won’t bother you at all. Failing to manage your obligation is going to definitely hurt your credit score so being proactive is what will keep you in step.