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Visualizing the Cost of Credit Card Interest

The Huffington Post The Huffington Post 4/11/2015 Robert Harrow

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One of the biggest problems with the language surrounding credit cards is the obscurity and disconnect around credit card APR. Looking through different card offers, you'll generally see credit card APR vary from 10% to 20% -- ValuePenguin research indicates the average sits at around 17.5%.
Part of what makes visualizing how much of a financial punch is packed behind a specific APR is that it is somewhat removed from the calculation. Firstly, APR stands for "annual percentage rate". Anybody who has had the displeasure of paying interest will tell you that APR fees are not something you pay annually, but monthly. Therefore, the rate being displayed on an annual basis can be misleading as to the actual costs you'll be facing on your bills. Secondly, the balance your APR is applied to is not straightforward. Before charging you interest, banks tend to look at what's called the "average daily balance". This number is determined by looking at your end-of-day balance, everyday throughout your billing cycle, and then averaging it. When all this is combined, the calculation to determine how much interest you'll be paying can be somewhat confusing.
To help with visualizing APR, let's look at a concrete example. Studies show that the average household credit card debt in the United States stands at $7,697. As mentioned previously, the average APR is around 17.5%. Since we don't know when during a month this hypothetical individual is making their purchases, we'll assume the average daily balance is equal to the average debt. We'll also assume that the individual can afford $500 monthly payments towards their bill. Over 12 months, our hypothetical individual would have paid over $860 in interest.
In order to see how variations in APR affect your interest paid over a year, let's see how the above situation would have ended with an APR of both 10% and 20%. With an annual percentage rate of 10%, and $500 payments on their balance, our sample individual pays $471 in interest over 12 months. That is $389 less than if the APR was 7 percentage points higher, or closer to the average. How about an APR of 20%? That would result in $997 paid over a year. Keep in mind that these values are obtained for an average balance of $7,697. For simplicity's sake, we assumed no new purchases were made onto the card throughout the year. If there had been additional purchases, the interest would have been significantly higher, assuming there was no change to monthly payments.
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All credit card users should do everything in their power to avoid paying interest. You should, ideally, never put charges on your credit card that you aren't able to pay off in full at the end of the month. As you can see in the situation described above, even in a conservative estimate, a 10% APR can end up costing you close to half a grand. Just think of all the things that money could be applied to instead. $471 could buy you 182 cups of coffee, 495 donuts, or roughly 209 cream cheese bagels!
If you are currently trapped in a cycle of paying credit card interest, one option available to you is to apply for a balance transfer credit card. These provide relief from paying interest for some promotional length of time - usually between 15 and 21 months. If you're already dealing with card debt you can't pay off, moving it over to one of these balance transfer credit cards can end up saving you hundreds of dollars. Just be sure you understand all the terms of your new credit card before you apply, and don't let yourself fall victim to unreasonable fees. Most balance transfer cards will charge a small fee for carrying out the transfer (~3%). Anything outside of this should be approached with caution.


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