This scenario makes it crystal clear just how much a low interest credit card can benefit your finances. Compared to a typical rewards credit card, with the MBNA True Line Gold, you would save $286 in interest and pay off your balance two months faster.
Even if we assume the rewards credit card in this example has no annual fee, you would still save a whole lot more on interest with the MBNA True Line Gold, even after considering its $39 annual fee. This clearly demonstrates that you shouldn't dismiss a credit card simply because it has an upfront annual fee. The cost of admission can be well worth it and help you save in the long run.
It’s important to also note that most low interest credit cards typically have lower annual fees to other types of credit cards, such as rewards credit cards.
How is credit card interest calculated?
As mentioned, APR stands for Annual Percentage Rate and is used by banks to calculate the interest you owe on a credit card if you carry a balance.
You might read the word “annual” in Annual Percentage Rate, and think that interest is owed once a year. However, in reality, even though interest is expressed annually, it’s actually calculated daily and charged monthly. Let's break it down to clear up any confusion.
- Consider Credit Card X with an APR of 15.99%. The daily interest rate would be 0.0438% (15.99% ÷ 365)
- To find the daily interest rate of a credit card, simply divide its APR by the number of days in the year.
Now, let's say you have a $3,000 balance on Credit Card X:
- Your daily interest rate would be 0.0438% (15.99% APR ÷ 365 days in the year).
- After one day, you would owe $1.3142 in interest (0.0438% x $3,000).
- Your total balance would increase to $3,001.3142 after one day ($1.3142 in daily interest + your original $3,000 balance).
- On the next day, your new balance of $3,001.3142 would also be charged 0.0438%, resulting in a balance of $3,002.69 on day two.
There are two important things to remember. First, it’s calculated daily. Second, interest compounds, meaning you’ll be charged interest on top of interest (although, this can vary depending on the card issuer). While a few extra dollars in interest from one day to the next might not seem like much, over time, it can quickly balloon, especially if you continue making new purchases on your credit card.
However, it is essential to note that if you pay off your card’s balance in full every month, you won’t owe any interest at all.
*This is a simplified example assuming no changes in day-to-day credit card activity.Many banks also charge interest based on your average daily balance over a monthly billing period.
What is the difference between a fixed and variable interest rate credit card?
Low interest credit cards come in two varieties: fixed rate credit cards and variable rate credit cards.
The difference between them is quite simple. Fixed rate remains the same, while a variable rate can change based on two key factors: 1) the bank’s current prime rate and 2) your credit score. When it comes to low interest cards, most banks offer either fixed rate or variable rate options but not both.
Each card type has its own advantages.
Fixed rate credit cards provide more straightforward terms. Once you’re approved for the credit card, you’ll know exactly what interest rate you’ll get and it won’t fluctuate regardless of changes in the bank’s prime rate or your creditworthiness. Fixed rate credit cards are also far more likely to come paired with limited-time balance transfer promotions, allowing you to consolidate debts on previous credit cards and pay them off at a lower interest rate.
Variable rate credit cards, on the other hand, have the potential to offer a rock-bottom interest rate (even lower than fixed rate cards), if you have excellent credit. However, the downside is that you might end up with a higher rate if your credit score is not great.
Regarding rewards, if you cannot consistently pay off your credit card in full, there is no point in pursuing points or cash back on arewards credit card. Most have an APR around 19.99%, and the interest you accumulate would devalue any rewards you earn. In simple terms: a rewards credit card is only worth it if you pay off your statement in full each and every month.
While most low interest credit cards don’t offer rewards, the fact that they charge a lower interest rate compared to rewards cards will put you in a better financial position when carrying a balance.
What is the minimum payment and when do you pay interest on a credit card?
Like any credit card, you must make at least the minimum payment on a low interest credit card on time every month. Minimum payments are typically $10 or 3% of your balance owing (whichever is higher) and must be paid every 30 days by the date shown on your credit card statement. Failure to do so can result in temporarily losing the primary advantage of low interest cards – their low rates.
For example, if you miss two minimum payments on your credit card within a one-year time frame, your annual interest rate could increase significantly, rising by 5% to 11%. Worse yet, you could get stuck with this higher rate for 6 to 12 months, during which you must make minimum payments each and every month. In addition to the interest rate hike, your credit score will be negatively impacted, and you may get hit with an additional late fee.
We cannot stress enough how important it is to always make your minimum payments on time. If you’re facing new financial difficulties and cannot afford to make your monthly minimum payments, you may want to consider not applying for a new card. Instead, reach out to your bank to inquire about deferring payments on your current credit card.
A deferral allows you to postpone minimum payments for at least one month and may also potentially include a temporary reduction in your interest rate. However, it is important to note that interest will still accrue and rates will return to normal after the deferral period ends. In simple terms, a payment deferral is a short-term solution to address credit card debt while on the other hand using a low interest card is a long term strategy that can help you continuously save on unnecessary interest charges.
How to reduce credit card interest?
If you want to save on credit card interest but can't pay off your balance in full every month, consider adopting some of these strategies:
- The first step is obvious: avoid making purchases on credit cards with a high (19.99%) annual interest rate and use a low interest credit card as your primary payment method.
- Use your credit card selectively. While credit may be convenient, if you regularly carry a balance, consider using debit or cash for most of your purchases and only resort to credit when absolutely necessary. This way, you can avoid accumulating a larger balance and incurring more interest.
- Always pay more than the minimum payment.By paying just a few extra dollars each month on top of the minimum, you can save hundreds of dollars in interest over time and pay off your balance faster.Read more about how credit card minimum payments work.
- Automate your credit card payments. It’s one of the best ways to prevent missed payments. Consider scheduling these payments on the day you receive your paycheque so a portion of your income goes directly towards your debt before you have a chance to spend it elsewhere. Make sure to leave enough for essential fixed costs like rent.
- Use proven debt repayment strategies. If you have multiple debts aside from your credit card, consider using methods like the debt avalanche or debt snowball method. Read more about these methods: How to pay off your credit card: 8 ways to reduce interest charges.
- Take advantage of balance transfer offers. If you have a substantial balance on your current credit card, you can transfer the debt over to a low interest card that comes with a balance transfer offer. For example, like the MBNA TrueLine Mastercard has a balance transfer offer for up to a year.
- Negotiate with your bank. It is worth contacting your bank directly to try negotiating for a lower interest rate. Banks want to retain customers, even if you don't pay your bill in full every month. Mention your loyalty as a long-time customer, express your intention to pay off your debt, and politely inquire about any available options. If the person you speak to cannot authorize a lower interest rate, ask to speak to a manager or someone higher up.
Keep in mind that if you do go with a balance transfer offer, depending on the card, you may have to pay an additional upfront transfer fee (usually 3% of your balance or less) but this small fee is insignificant compared to the interest you would pay if you kept your balance on the old card. One final note: remember that balance transfer offers have a limited duration, and after the promotional period ends, the interest rate will revert back to its original rate.
Also read:
- The best credit cards in Canada
- The best balance transfer credit cards in Canada
- The best no fee credit cards in Canada
- How to pay off your credit card and reduce interest charges
