Credit cards have become a vital component of the global economy. As of Q3 2022, there were over 510 million credit cards in use worldwide, according to the consumer credit reporting agency TransUnion. The average credit card debt per borrower stood at slightly over $5,400 in the same period.
Perhaps the most confusing aspect of credit cards is how interest is calculated. Different types of transactions are treated differently when it comes to calculating interest and the fees you pay.
Check your monthly statement for a section that identifies the rate of interest that applies to each type of transaction.
Here are five types of credit card interest charges and how you can avoid being stung by them.
1. Purchase interest
The most common type of credit card transaction is when you buy something online or at a physical shop. With a few minor exceptions where these are treated as cash advances (see below), they are considered to be purchases and attract purchase interest.
This is the easiest type of interest to avoid. Most cards have an interest-free period—it is important to understand how long that period is and the precise rules surrounding it.
Pick a credit card with terms that work for you, spend cautiously, and pay your full monthly bill on time.
You will not pay interest on your purchases if you pay the closing balance on your credit card in full every month by the due date.
2. Cash Advance interest
If you use your credit card to withdraw cash from an ATM, a bank branch, or using internet banking, it is treated as a cash advance which often incurs a higher rate of interest (and applies from the date of the transaction even if you pay the month-end balance in full).
Some purchases, like traveler’s cheques or foreign currency are treated as a cash advance.
Similarly, some bills paid over the counter at a post office and some BPAY payments to merchants who don’t accept credit cards may also be treated as cash advances. Purchase of lotto tickets will usually be treated as a cash advance.
Contact your bank to clarify which of these terms, if any, apply to your credit card.
American Express credit cards generally do not provide for cash advances other than for foreign exchange or travellers cheques.
A ‘cash advance’ can be useful when you need cash in a hurry, but it can also be expensive. There is generally no interest free period for cash advances, the interest rate can be higher than for purchases, and there is usually a fee for the advance itself - up to 2%.
Use your credit card to withdraw money only in emergencies and try to pay back the full amount as early as possible to avoid interest accumulation.
3. Balance transfer interest
Balance transfer offers can be a great way to quickly repay your credit card debt, but there are some vital points to consider before you jump in.
First, there’s a lot of variation in the interest rates on balance transfers. You can usually find a zero % offer so keep your eyes peeled for those. These interest rates are usually for a fixed period.
Caution: If you don’t pay off the entire balance transfer before the introductory period ends, you will have to pay a higher interest rate on what’s left until you finally pay it off.
If you use a balance transfer facility, you will be treated the same way as if you didn't pay your balance in full by the due date. That means any new purchases don’t get an interest-free period and you will pay interest from the date of your purchase.
If you want to use the balance transfer facility don’t use the card for anything else until you have paid off the transfer in full. Use a separate card for your day-to-day purchases and pay this one off in full every month.
It’s worth checking the fine print– check what rate will apply to the remaining balance transfer amount if you haven't repaid it in full by the end of the promotional period. Sometimes this is the purchase rate but more commonly the (usually higher) cash advance rate applies. This could make a big difference to how much interest you pay.
4. Interest on fees
Most card issuers now treat fees (like annual card fees) as purchases. This means that you will generally benefit from the interest-free period for these as well as long as you pay your bill in full by the due date. The Purchase rate applies. if you don't.
5. Special offer interest rates
These can be the most confusing and lead to complaints and queries. Card issuers regularly offer introductory or lower interest rates for a certain period (often 3 or 6 months). These types of offers are especially popular with issuers of Store Cards.
When the offer period expires, the rate usually reverts to a much higher standard interest rate.
Take note of the expiry date, the duration and details of the offer and the rate that will apply when the offer period is over.
Remember it usually applies to the period for which the interest is calculated not the period you made the purchase. As always it pays to read the fine print.
Understand How Credit Card Interest Is Calculated
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Vince Scully
Life Sherpa®
With over 25 years in Financial Services from consulting to management, Vince Scully is the go-to guy for wealth management and financial advice. Vince founded the Calliva Group; a fund manager, product issuer, advisor and lender to Government and private clients. Vince is an advisor to the Wealth Management Industry, and prior to his role as CEO at Calliva, a senior member of Macquarie bank’s infrastructure team.
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