Quick, you’ve got a gun to your head and the criminal is asking you to calculate the interest you’ll pay if you don’t pay off your entire balance before the payment due date. You’ve heard the term APR, you know that it means annual percentage rate, so thats a start. Lets assume for the sake of this exercise that the amount of money you owe is $1,000 and your APR is a cool 15% (round numbers and all). What calculation would you make to save your life? If you said $1,000 times 15% you’d be….incorrect. Welcome to the world of credit card interest. Now, as we’ve said in the past, its important that if you’re going to pursue points of any kind (travel/cash back, etc.) that you’re able to pay off your card in full every month. Why? Well as you’ll see here shortly, paying interest on your credit card balance will quickly wipe out any benefits that you would’ve seen from your points and miles.
For the rest of this article we’re going to use the Chase Sapphire Reserve as our reference point. This will give us some actual numbers to use and if you’d like to see them for yourself you can do so by clicking here.
Types of Credit Card Transactions
There are three types of credit card transactions that you can make; purchases, balance transfers, and cash advances. Each of these different transactions has their own APR’s and individual fees that you may have to pay when making such a transaction. Lets go through each of them one-by-one and define what they are.
- Purchase – When you swipe your card at the gas station, grocery store, movie theatre, etc. you’re making a purchase. For most people this will represent the vast majority (95%+) of their credit card expenditures. For the Sapphire Reserve we’re going to pay an APR of between 16.99% and 23.99% based on creditworthiness. Note that the APR will vary based on the prime rate (which we’ll touch on in a moment).
- Balance Transfer – If you transfer an existing balance from one credit card to another (in this case the Sapphire Reserve), you’re going to pay the same APR as with purchases, 16.99% to 23.99% and this too will vary with the prime rate. Note that for balance transfers with the Sapphire Reserve you’ll also pay a fee of $5 or 5% of the amount of each transfer, whichever is greater.
- Cash Advance – A cash advance allows you to use your credit card as a means of getting cash from say an ATM or a bank. While this could be tempting in a pinch, the fees and APR associated with doing this can be exorbitant. For the Sapphire Reserve you’ll pay an APR of 25.99% as well as $10 or 5% of the amount for each transaction (whichever is greater).
We mentioned prime rate above, and you’ll see it mentioned on most credit card pricing pamphlets. This rate is simply a number which is 3 points above the federal funds rate set by the federal reserve. In our Sapphire Reserve pricing document the prime rate is 4.25% as of 8/1/2017. As the prime rate changes, so will the APR that you pay on your credit card debt.
Important Dates to Understand
Now that we know the different types of transactions and fees associated with them, we’ll look at important dates before getting into actual calculations. Each credit card will have 12 statement periods throughout the calendar year. Each statement period will bring with it a statement and on that statement you will see your statement balance, as well as a statement balance due date. See the following screenshot for an example:
Here we see that the previous balance was for $300 and the user paid $385.14 during previous statement period. Note that if the user paid less than $300 they would be charged interest on the remaining balance. Since the amount paid was greater than the amount owed, no interest will be charged. Moving forward we note at the top right that the new balance is $2,086.65. This is the amount that the user must pay by 01/08/18 in order to avoid being charged any interest. Midway down the left hand side you’ll note the opening/closing date of 11/12/17 – 12/11/17. This means that this account summary reflects all transactions within that ~30 day window. The difference between the closing date and the payment due date is known as the grace period. So long as the user pays off the full balance before the due date, they will not be charged any interest. The Sapphire Preferred pricing information sheet confirms as much:
Your due date will be a minimum of 21 days after the close of each billing cycle. We will not charge you interest on purchases if you pay your entire balance by the due date each month. We will begin charging interest on balance transfers and cash advances on the transaction date.
So what happens if you do not pay off the full balance by the due date? Lets get out our calculators.
Calculating Credit Card Interest
For all cash advance and balancer transfers you will be paying interest on the transaction date. This means that the grace period we mentioned previously does not apply to those transactions. This explains why the fees can grow so quickly and why you want to be very careful if you plan on making these types of transactions. Side note, we recommend never using cash advance (save for the most extreme situations), and only execute a balance transfer if you’ve got a card that offers some sort of promotional APR for the transfer.
With that in mind lets get to calculating our interest payment. For the sake of this example we’ll say that the user paid off $1,086.65 by the payment due date, and now owes $1,000 moving forward. When calculating the interest payment the credit card company will (most likely) use the “daily balance method”. This means that they’ll charge you interest based on your daily balance, and it will compound daily. So on January 9th the interest will start to accrue at a rate of .000465479 per day. Wondering how we got that number? While you’ll almost always see the interest rate listed as APR (annual percentage rate) we actually want to know what the DPR or daily percentage rate is. To calculate that we’ll take our APR, which for this example we’ll say is 16.99% and divide that by 365 days in a year.
0.1699 / 365 = .000465479
Now we’ll take our daily average balance and multiply it by our DPR and the resulting number is the interest we’ll pay for that day. $1,000 * .000465479 = $0.465479. The daily compounding part means that our new daily balance once we get to January 10 is $1,000.465479. On and on this process will go until the full balance has been paid off. The following shows us what it would look like it we did not make any payments for 15 days and made no additional purchases.
In this hypothetical situation we’re saying that we made a full payment on the 26th and paid no additional interest. But as you can see up until that point we accused $7.47 in interest, and we also did not make any additional purchase. If we did make additional purchases that would affect our daily average balance and that number would actually grow larger. Furthermore, if we had been charged any fees for things like late payment, returned payment, etc. those too would get tacked onto the principal balance.
Other Credit Card Fees
There are a few other fees that you should be aware of and try to avoid paying at all costs.
- Late Payment Fee – If you do not make at least the minimum payment by the due date you’ll get charged a late payment fee. This is generally a variable fee based on the total balance of the card. For the Sapphire Reserve you’ll pay $37 if the balance is greater than $250, $27 if its between $100 and $250, and $15 if its less than $100.
- Return Payment Fee – If your checking account as NSF (Insufficient Funds) but you try and make a payment to your credit card anyway, that check will bounce and you’ll get charged a return payment fee. For the Sapphire Reserve this fee is up to $37, and in most cases your checking account is going to charge you a fee as well.
- Annual Membership Fee – This is a fee for simply having the credit card in your wallet. Some cards have no fee, while others like the travel cards we love tend to carry them. The Sapphire Reserve has a $450 annual fee and also charges $75 for each additional user.
- Foreign Transaction Fee – Using your card outside of the United States (or home country of your card) can result in a foreign transaction fee. These generally range between 1 and 3% and they’re added to the purchase price. Most premium travel cards waive the foreign transaction fee but you’ll want to double check your card before spending overseas.
- Over-The-Limit Fee – If you go over your cards predetermined available credit, you may be charged an over the limit fee. The Sapphire Reserve does not list this on their pricing information sheet, but many cards do. Be sure to check with your issuer before spending over the limit.
How to Avoid Paying Fees
So now that we know how all these fees work, how can you avoid paying them? Simply put, pay your credit card bill in full and on time every single month. Be sure to keep an eye on your balances every day as well as the money you’ve got coming in and going out. If for some reason you’re unable to make a full payment before the due date its still important that you pay as much as you can. This will help reduce your daily average balance and ensure that you’re not hit with a late payment or other fee which can dramatically increase your debt.
If you’d like personal advice or assistance with anything we’ve discussed here today please feel free to reach out. We’d love to try and help.