By David Chaston
Can't pay your full credit card balance this month? Then you will know that the main banks will charge you interest at about the rate of 20.95% per annum for the ability to delay your payment.
Actually, there is a range of rates on offer from a low of 12.95% pa (the Co-operative Bank Fair Rate Mastercard plan) to 25.99% pa (at Gem Visa).
By now you will know that these rates are very high, and on top of them, there is the annual fee. And if you use your credit card to make a cash withdrawal, the rates are higher still.
But what you probably don't know is that these rates are declared on an "annual percentage rate" basis. If you use the delayed payment option every month, the effective annual percentage yield is even higher.
And that is because there will be interest on interest. Interest is charged every month and debited to your account. That forms part of your next month's opening balance on which the next month's interest is based.
In reality, that means your dollar interest cost could be more than 10% higher than you might otherwise think. For a "12.95%" rate, the effective rate is 13.79% (an 84 basis points or 6.5% premium). For the "25.99%" rate, the effective rate is 29.41% (a +342 bps or 13% premium).
Here is an element of our online credit card interest rate table with the effective cost of not paying your balance off over any month in a year added:
|Plan||Interest free period||Fee primary $||Balance transfer %||Balance transfer period||Cash Adv
|ANZ||Low Rate||55||35.00||1.99||12 mths||20.95||13.90||14.87|
|Airpoints Visa Platinum||44||150.00||20.95||20.95||23.15|
|Visa Light||55||0.00||0.00||6 mths||22.95||13.50||14.41|
|BNZ||Advantage Classic||55||40.00||0.00||6 mths||22.95||20.95||23.15|
|Advantage Visa Platinum||55||90.00||0.00||6 mths||18.95||18.95||20.75|
|GEM Visa||Gem Visa (<$250.00)||55||52.00||25.99||25.99||29.41|
|Gem Visa (>$250.00)||180||52.00||25.99||25.99||29.41|
|SBS Bank||SBS Visa||55||0.00||21.50||18.50||20.21|
|The Warehouse||Purple Visa||55||0.00||22.95||19.95||21.95|
|Warehouse Money||Warehouse Money||55||0.00||22.95||19.95||23.15|
The effective cost of debt would be even higher if we included the annual fee.
It is true that if you incur interest for just one month, the rate charged is also the effective rate. But if you let it slide, you are boosting the bank's interest earnings, from you, for every month you do that.
The maths is straightforward. What you might assume is the formula, namely: [ APR = periodic rate × number of periods in a year ] isn't what is used. What is actually used is the more accurate one for compounding interest, namely [ APR =(1+periodic rate) ∧ number of periods −1 ].
The power of compounding interest works well for bank earnings. You may think you are paying an eye-watering 20.95% pa rate but in fact if you don't pay off that debt within one month and let it drag for a year it could be 23.15% in a year. Or more.
*This article was first published in our email for paying subscribers early on Thursday morning. See here for more details and how to subscribe.