How Is Interest Charged On My Credit Card?
Table of Contents
You’ve just received your credit card statement and you’re shocked to see that along with your spending transactions, you’ve been penalised with finance charges and late payment charges that total up to a rather indecent amount.
What happened?
You were only a couple of days late in your payment last month.
Don’t fret. Read on for the scoop on the interest rates for your beloved plastic so you’re never caught by surprise again when you receive your next statement.
1. Compounding interest rates
Interest is essentially ‘rent’ on money. When you use your card, you’re borrowing the bank’s money to spend, and in return, the bank charges you a “rent” on that money if you don’t pay them back within a certain period.
Bringing that to another level, compounding interest is, in simple terms, interest charged on interest. For each day you owe the bank money on your credit card, the bank charges you interest on that amount. The following day, you will be charged interest on your total outstanding balance, which would be the amount the bank has lent you, plus “yesterday’s rent”. The day after, you will be charged interest on your new outstanding balance, i.e. amount you borrowed plus two days of “rent”. The same thing happens the day after and continues perpetually until you pay off all your debt.
2. Interest is compounded on a daily basis
In the example above, the interest was compounded daily.
That’s because it’s exactly how banks are calculating your interest charges – on a daily basis. What this means is that the interest rate per year given to you by the bank is divided by 365 days (e.g. 15% divided by 365), and that rate (0.041% in our example) is multiplied to your outstanding balance every day until all your debt is cleared.
Note: Daily compounding interest can make a difference in the long run. In the case of the 15% rate, compounding that daily would effectively make it 16.18% a year – that’s RM161.80 on a RM1,000 debt (not RM150). So, if you have the financial capacity, never pay tomorrow what you can pay today!
3. Credit card tiered interest rates
If you’ve read the fine print on our credit card comparison table, you’ll notice that the interest charges differ depending on your payment behaviour. This is because Bank Negara Malaysia has introduced a tiered structure to promote good financial discipline.
- Not more than 15% per year – when you make minimum payment for 12 consecutive months on time
- Up to 17% per year – if you promptly make minimum payment for at least 10 months in a 12-month cycle
- 18% per year limit – otherwise
If you’re a new customer with the bank, which tier would you fall under?
As a new customer, you’re automatically charged interest at the highest tier until you have a 12-month payment record with the bank, and you will only enjoy the lower interest rates from the 13th month onwards after you’ve displayed good payment behaviour.
Note: Look out for low interest credit cards offered by some banks, which give you lower rates without having to prove yourself first. Alternatively, spend wisely and religiously make full payments to avoid paying interest charges at all!
4. 20 days interest-free period
It’s rather unfortunate, but most things in the world aren’t really free. If they are, your brain is wired to think that there has to be a catch somewhere. And you’re right to think so.
While the banks are genuinely giving you 20 interest-free days for purchases you made on your card, this benefit comes with a condition. That is – you must promptly settle your repayments in full.
If you’re paying anything less than your full debt, you don’t get the interest-free grace period and your interest charges start accumulating immediately from the day you make your purchase.
5. Late payment charges and other charges
So, you’ve been diligently making full payments promptly every month to avoid exorbitant interest charges. Unfortunately, you slip up one day and find yourself behind in your payment by a couple of days.
You will need to pay for more than just late payment charges. What you may not know is that you will also be penalised with interest charges. They are also listed as finance charges, as they call it in your statement. This is calculated from the posting date of all your transactions, and not from your payment due date. This is because your 20-day interest-free period no longer applies.
This can be quite painful to your wallet if you’ve made a huge purchase at the beginning of your billing cycle (remember that interest is being compounded daily!), so set a recurring reminder so that you’ll always pay your bills on time.
