Interest and fees

Banks do not issue credit cards as a public service. Cards earn them billions, and knowing exactly where that money comes from tells you exactly how to avoid being the one paying it.

The purchase rate

The headline number on a card is the purchase interest rate, and on Australian cards it is commonly around 20% a year, with plenty higher. That is not a typo. Money that costs a home buyer around 6% costs a card holder more than three times as much, because card debt is unsecured: there is no house or car for the bank to take if you stop paying, so the rate carries all the risk.

How the interest actually lands

If you break the interest free condition, interest is calculated daily on what you owe and added monthly. A $1,000 balance at 20% costs roughly 55 cents a day, which sounds tiny, and that is the design. It compounds into about $200 a year if the balance never moves, approximately, and because unpaid interest joins the balance, next month's interest is charged on this month's interest too.

A month of interest, line by line

It helps to watch one month happen slowly, so here is an illustrative walk through on that $1,000 balance at 20% a year. The daily rate is the annual rate divided by 365, so 20% over a year is about 0.055% a day, which on $1,000 is roughly 55 cents. Leave the balance untouched for a 30 day month and the bank adds about 30 times 55 cents, near enough to $16.50, at the end of the cycle. That $16.50 does not sit in a separate box. It joins the balance, so the next month you are being charged interest on $1,016.50 rather than $1,000. The extra is small at first, cents on cents, but it is the mechanism that turns a stuck balance into a growing one.

Now stretch that same illustrative case across a year with nothing paid off. Each month adds a little more than the last, because each month starts from a slightly bigger balance, and by the end the $1,000 has grown to somewhere near $1,220 through compounding alone, roughly. You spent $1,000 and, a year later, owe $1,220 for the privilege of not clearing it, without buying a single new thing. That is the quiet arithmetic every card is built on.

Cash advances: the expensive button

Using a credit card to withdraw cash from an ATM, or for things banks treat like cash such as gambling, is a cash advance. It is the worst deal on the card: a higher interest rate than purchases, an upfront fee, and no interest free period at all, so interest starts the second the money leaves the machine. There is almost no situation where a cash advance is the right move.

The fee list

• Annual fee: the yearly cost of holding the card. Plenty of basic cards charge none, so paying one needs a reason.
• Late payment fee: charged when even the minimum misses the due date, often $20 to $30.
• International transaction fee: usually around 3% on purchases in foreign currencies, including many websites.
• Cash advance fee: an upfront percentage the moment you treat the card like an ATM card.

The catch when you pay most of it

Here is a misconception worth clearing up, because it costs people real money. Many assume that if they pay off almost all of a balance and leave a small amount, interest that month is charged only on the little bit left behind. On most cards it does not work that way. Once you have broken the interest free condition by not paying in full, the interest for that period is worked out on your daily balance across the whole month, including all the days before you made the payment. So paying $950 of a $1,000 balance on the due date does not mean interest on $50. It can mean interest on the full amount for every day it sat there, then interest on the leftover until that too is cleared. The lesson underneath is blunt: with a card, paying nearly all of it is not nearly the same as paying all of it.