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Credit Cards

What is Interest and How Does It Work?

Date:
November 16, 2020

Do you know how much interest you pay on your credit cards every year? Credit cards are convenient, but every time you use them to make a purchase - and don’t pay it off in full and on time at the end of a billing cycle - you’re paying more than the purchase price. You’re also paying interest to your bank.

What is an interest rate?

An interest rate is either the cost of borrowing money or the reward for saving it. It’s calculated as a percentage of the amount borrowed or saved.

How do interest rates work?

When you don’t pay off your credit card balance in full, your bank applies your interest rate to the total unpaid portion of your balance. Following the terms you agreed to when you accepted your credit card, you’re required to pay at least the bank’s interest charges every month. 

Banks typically charge a higher interest rate on credit cards than other kinds of loans. Banks also charge higher rates to people they think are a higher risk. Banks determine your risk by reviewing your credit score. The higher your score, the lower the interest rate you’re likely to pay.

How is APR different from the interest rate?

Your credit card’s APR (or “annual percentage rate”) is different from its interest rate. Your card’s APR includes your bank’s interest rate plus their other fees and charges, many of which are charged only once or annually. 

With that in mind, weigh the difference like this: your interest rate tells you what you’re charged each month. Your APR includes all of the costs over the life of your loan or credit card.

What is an 0% APR credit card?

‍Many credit card issuers promote 0% APR cards to attract new customers. These “introductory” offers typically last between 6 months and 21 months, and they’re often promoted to encourage a balance transfer, where you transfer your balance from a card or a loan with a higher interest rate to a 0% APR card. 

Balance transfers sometimes require an extra fee (commonly 3% - 5%), but with 0% APR over the introductory period, you have more time and flexibility to pay off your debt. 

How can I lower monthly interest charges?

The easiest way to lower your interest charges is to avoid them in the first place: pay your credit card bills in full and on time every month. If you need help managing payments, use a debt management tool like Bright. 

A debt transfer card can also help - when you transfer balances from high-interest cards to a card with an introductory rate of 0% or a low interest rate. 

Another common approach is the debt avalanche method for managing card debt. With this payment strategy, you’ll identify which card is charging the most in interest and fees each month. After paying the minimum due on your other cards, you’ll pay as much as you can to clear this card. 

How can personal loans lower interest charges?

Some people use a personal loan to pay off their credit cards. If you can secure a personal loan with an APR lower than your credit cards, it can be an effective strategy. 

You’ll use the loan’s lump sum to pay off your card, then make one predictable loan payment each month at a lower interest rate. 

How can Bright help?

Bright offers personal loans to all qualified users. We can guide you through the process, pay off your cards for you and set up one new monthly loan payment, saving you interest charges and other costs automatically. 

Your personal Bright Plan can also help you pay less in interest fees on your credit cards, automatically. 

Once you’re connected to Bright, we’ll analyze all your debt and your spending habits, calculate how much you can afford to pay, and then make payments that save you more. 

Month after month, Bright makes your payments for you, so you’re avoiding late fees - and always paying down your balance, lowering the interest you pay. 

Content Team
Bright Money

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