Facts About Interest Fees on Credit Cards

Credit cards can help your credit, but know the facts behind interest fees first.

Credit cards can help make large purchases more affordable, since consumers can pay off bills over time. They also serve as financial safety nets, so consumers can rely on credit cards in the event of unforeseen medical bills or auto repairs. Used responsibly, credit cards can contribute to good credit. But credit card companies make money from interest, and these fees can make holding a credit card account expensive. Knowing the facts can help protect you.

Calculating Interest

Credit card companies calculate interest fees in different ways. The most common method, known as the "average daily balance," calculates your balance daily based on payments, in some cases, purchases. At the end of the billing cycle, these daily balances are added together and then divided by the number of days in the payment period. Another method credit card that companies use for calculating interest is known as "adjusted balance." Under this calculation, payments are subtracted throughout the billing cycle but purchases aren't added until the end, so that consumers don't pay interest on their purchases unless they carry over into the next billing cycle. A third method for calculating interest fees is known as a "two-cycle balance." Average daily balances are derived from two billing cycles rather than just one. Consumers may pay more interest under this calculation because interest is retroactively applied to the initial purchase date if not paid in full by the end of the billing period.

Compounded Interest

Part of the danger in accumulating debt and interest fees on credit cards lies in compounded interest. Because interest fees are added to the credit card's balance, consumers wind up paying interest on interest fees accumulated from previous billing cycles. As interest compounds, the card's balance grows.

Credit Score

Your credit score helps determine interest fees set by credit card companies. Consumers with high credit scores often receive preferred terms on credit card accounts, including higher balance limits, lower interest rates and lower fees. Consumers with low credit scores are offered just the opposite, and individuals with poor credit may have difficulty obtaining any type of credit card.

Universal Default

Credit card companies sometimes mail out attractive credit card offers to consumers in the hopes of convincing you to open an account. Introductory interest rates may be quite low---even "no interest" for a specified amount of time---but be aware that most credit card contracts contain fine print describing the company's "universal default" policy. Under universal default policies, missing one credit card payment with a particular credit card company may mean steeply increased interest fees for that card and for all other credit cards you hold. Another thing to keep in mind about credit card offers, even those with tempting terms: opening multiple credit accounts at the same time can result in lowered credit scores.

Negotiation

If you have a positive history of making on-time payments with your credit card company, it's possible to negotiate lower interest rate terms. Call the company and ask if you qualify for lower interest fees; they may say no, but it's worth a try. If you receive a lower-interest offer from another company, call your current provider and ask them if they can match the rate.

References

• University of Maryland University College: How Does Your Credit Card Calculate Interest?
• Consumers Union: Credit Card Facts and Stats
• Consumer Credit Card Guide; 10 Credit Card Industry Facts that You Probably Don't Know; January 2010
• Federal Trade Commission: Choosing A Credit Card
• Reward Programs; 12 Little Known Facts Every Cardholder Should Know; February 2007