Credit Cards: How does credit card interest rate work and how to get a lower rate?

If you are using a credit card then you are entitled to 40 to 50 days of interest-free period to pay your bills. But in case you don’t clear your credit card bill during these days, or you pay only the minimum due amount, you will be liable to pay interest on the days starting from the transaction date.

Let us understand how this works. The interest rate on credit cards is represented by the Annual Percentage Rate (APR) in the credit card statement. As the terms indicate, it is applicable for the entire year rather than for the month.

Formula to calculate interest rate

The formula to calculate interest rate is as follows:

Formula = (Number of days from the date of transaction) x (Outstanding Amount x monthly interest rate x 12)/ 365

Let us assume that the transaction date is 5 September 2024 and the amount is ₹10,000. Statement date is September 7, 2024. 

Minimum due is 5 percent of the bill i.e., ₹500.

Total amount due is ₹10,000.

The due date is Sept 27, 2024.

Interest rate is 42 percent per annum.

Next statement date is 7 Oct, 2024.

Number of days till due date when partial payment was made = Sep 5 to Sept 27 = 23 days

Number of days till next statement date = Sept 27 to Oct 7 = 10

APR = 42 per cent.

So, the total interest will include interest on total amount from the date of purchase till partial payment date + interest on balance amount from date of part payment till the date of next statement.

Interest till partial payment date = 10,000 X 0.42/365 X 23 = 264.66

Interest on till next statement date = 9,500 X 0.42/365 X 10 = 109

Total interest = 264.66 + 109.32 = ₹373.98.

So, here we can see that the credit card user ends up paying this interest despite paying the minimum due. And had he paid the entire amount before the due date, there would have been no interest at all.

Things to do to save on interest rate:

I. In order to save on interest, it is vital to pay your credit card bill on time. Every bank gives an interest free grace period during which no interest is payable.

II. Refrain from paying the minimum due. As shown above, when the minimum due is paid, interest is charged for the full amount during the entire period starting from the transaction date.

III. Check the interest rate before applying for a credit card. Although some banks charge an annual fee, the interest rate could be higher.

IV. Keep a high credit score that is inversely proportional to the interest rate charged on credit.