How does credit card interest work?

How does credit card interest work?

A credit card could be a useful part of your financial toolkit, whether it’s for making everyday purchases or to pay a bill in emergencies, or when you don’t have funds or cash available.

Credit cards can help with cash flow because they allow you to make purchases without using your own money. But to maximise the potential benefits of having a credit card, you should think about the optimal way to use it, and know how credit card interest works.

Calculating credit card interest

Interest is calculated on the daily basis and charged at the end of the statement period unless you are eligible for an interest free period. It’s not just on new purchases made with the card, but interest also includes your cash advance transactions, balance transfers, and balances from previous months.

Here are some helpful definitions of the types of credit card interest:

• Purchase rate: the interest rate you pay on purchases made with your card
  
• Cash advance rate: what you’re charged when you use your credit card to withdraw cash from an ATM. This also applies to cash equivalent transactions, such as paying for gambling services, lottery tickets and foreign currency. This rate is usually higher than the purchase rate and interest-free days don’t apply
• Balance transfer rate: usually a low rate offered to customers who are consolidating balances from one or more credit cards to a new credit card
   

The date that your statement is issued is called the ‘statement date’ and the period from one statement date to the next statement date is called the ‘statement cycle’ or ‘statement period’.

A statement cycle doesn’t have to begin and end on the first and last day of the month –  it is usually 30 days, and generally ends on the same day of each month.

Some credit cards offer a low (or no) interest rate per month, which may make them a good option for those who carry a balance each month, or who want to save on interest charges. 

What is an interest free period?

An interest free period is the amount of time (usually in days) where you can make purchases on your credit card without being charged interest, as long as you pay the closing balance by the due date on your statement.

Many Westpac credit cards offer up to 45 or up to 55 interest free days, which means you can make purchases without using your own money, and at the same time enjoy the freedom of not having to pay it back for up to 45 or up to 55 days when you pay off the closing balance in full by the due date every month.

However, it is important to note that an interest free period is based on your statement cycle rather than the purchase date. Not every purchase will receive the full up to 45 or up to 55 interest-free days – it depends on when you make the purchase within your statement period.

So, consider a statement cycle that runs from 1 January to 31 January with an interest-free period of 55 days. If you bought a laptop on 1 January, you won’t have to pay for it until 24 February, allowing you to take advantage of the full 55-day interest-free period.

Now, if you purchase a new phone on 31 January, it falls within the same statement cycle, and you’ll still need to pay by 24 February. However, this only gives you an interest-free period of 25 days.

Understanding that the length of the interest-free period for each purchase depends on when you make the purchase during the statement cycle, could help you make the most of your interest free days. 

When and why you may attract interest

You may attract interest on your credit card for a few reasons:

Overseas transactions

Depending on your card’s terms, using your credit card overseas can lead to foreign transaction fees for transactions made in a foreign currency or at an overseas merchant. Some cards offer no fees on foreign transactions.

Cash advances

Cash advances typically attract interest immediately, without any interest-free period, and often come with a higher interest rate. This includes withdrawing cash from an ATM and cash equivalent transactions, such as buying lottery tickets, gambling services, and foreign currency.

Balance transfers

Balance transfers involve moving debt from one or more credit cards to another, often with a promotional interest rate. This could be a useful strategy for consolidating your debt, but it’s important to look out for any balance transfer fees and note the interest rate once the promotional period ends. 

Interest on your unpaid balance

If you don’t pay your balance in full by the due date, interest will be charged on the remaining balance. You’ll also attract interest charges and late fees if you pay your credit card balance late.

What to look for on your statement

Your credit card statement provides helpful and important information about your account:

• Statement balance: the total amount owed at the end of the billing cycle
• Minimum payment: the minimum amount you need to pay to avoid late fees
• Interest charges: the interest you’ve accrued during the billing cycle
• Transaction summary: all the transactions you’ve made during the cycle
• Payment due date: the date you need to pay your balance to avoid interest charges and late fees

Tips to stay on track and avoid paying interest

There are a few things you could do to help avoid paying interest:

• Pay your outstanding balance on your statement in full by the due date
  
• Take advantage of interest-free periods by planning your purchases
• Review your monthly statements for any errors or unauthorised charges
• Use cash advances only in emergencies
• Find out how promotional offers work before you accept them
• Set up reminders to make repayments on time
• Set up Card Autopay to automatically pay off your account every month

To sum up

Understanding how credit card interest works could be an important factor in managing your debt and avoiding unnecessary costs. The amount of interest you pay depends on the type of card, the types of transactions you make and when you make repayments. By knowing these details, you’ll be able to get the most out of your credit card and help minimise the amount of interest you pay.