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Compounding interest has a fierce effect on the cost of letting your credit card balance roll over each month, boosting sky-high rates even higher

Compounding interest has a fierce effect on the cost of letting your credit card balance roll over each month, boosting sky-high rates even higher

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
            APR APR yield
ANZ Low Rate 55 35.00 1.99 12 mths 20.95 13.90 14.87
  Airpoints Visa 44 65.00     20.95 20.95 23.15
  Airpoints Visa Platinum 44 150.00     20.95 20.95 23.15
  CashBack 55 60.00     20.95 20.95 23.15
  CashBack Platinum 55 125.00     22.95 20.95 23.15
ASB Visa Light 55 0.00 0.00 6 mths 22.95 13.50 14.41
  Rewards 55 40.00 0.00 6 mths 22.95 20.95 23.15
  Gold 55 80.00 0.00 6 mths 22.95 20.95 23.15
  Platinum 55 80.00 0.00 6 mths 22.95 19.95 21.95
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
  Warehose Money 55 0.00     22.95 19.95 21.95
TSB Bank Standard 55 30.00     18.50 18.50 20.21
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.

*Also see; Why the regulators should take a look at the credit card market.

*This article was first published in our email for paying subscribers early on Thursday morning. See here for more details and how to subscribe.

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Hi David,
Even though Gem has the highest rate ,you can choose your buying wisely with GEM by getting interest free without big set up costs as long as you pay your account on time.
The only pitfall is if you have 2 or 3 interest free things on Gem you have to manage your payments correctly.
Also when a card is stolen Gem is Fast to put a stop on where Warehouse Visa no fee took 4 hours to put a stop.
If you can afford to pay your credit card off , its the way to go.
David I am concerned about the false ill informed people that are making false comments on here about GEM , there are no loaded prices it may be a dog of card but it suits our needs if we pay on time and if you use interest free and pay card on time it great

You can do far better than GEMs 6 months interest free, the minimum of $107 ($55 establishment + $52 annual) of fees mean you need to spend a far bit interest free to get back to zero. I haven't run the calcs, but I think kiwibanks low rate card at 13.45% and $24/6mth fee and making minimum payments would see you marginally ahead of the GEM card up to 6 months, and then miles ahead after that due to the interest rate being half.

And if you really want to go to town, do a 1year 0% interest transfer to the BNZ card, then use that money to buy your crap, and make sure you pay it back before the year is up.

The Gem card is a dog of a thing, no matter how you use it there is a better credit card deal out there. (or simply not ticking stuff up on credit cards in the first place..)

$55.00 fee is a one off it just a normal credit card starting off fee
If I spent $250.00 on groceries I get 6 months to pay it off where I would start paying interest on the Kiwibank card. $55.00 is not charged on every new transaction , no brainer, I would rather use my money getting interest or buying a house.

Its not normal at all, I've never paid an establishment fee for a credit card, usually the opposite, the first 6 months or annual fee waived for joining up. In fact, most credit cards I've signed up for have had a sign up bonus, spend $x in the first 3 months and get ($y airpoints/hot points/ other rewards).

Name me a NZ bank issued credit card that has an establishment fee and an annual fee?

No one has an establishment fee. GEM just use it to hide the true cost of their product. I guess they need to do this with being a replacement to Hire Purchase agreements that used to be around.

ASB low rate visa has interest free period of 6 months for any purchase $1000 or higher and has no annual fee at all and low interest rate

Still cant beat up to 60 months interest free if you keep payments on time no one can offer that , not even Qcard

Warehouse visa has just introduced a fee 0F $55.00 with no annual fee .I suppose when you have say 20k on 60 months interest free they have the right to charge a fee but its only once where likes of smiths city charges a fee on easipay for every transaction

Hot points costs and when I started gem may years ago my annual fee was waived by negotiation you just don't know how use the benefit of Gem
Its good business/personal tool if you stick to the rules

You sure are shilling hard for GEM.. whats your relationship with them? One of the retailers trying to drag people into their overpriced (but interest free) offers?

GEM, purple, etc.. they are just the new HP methods where retailers sucker you in with low payments now on goods you don't need with loaded retail prices.

Nope just joe public mate stating facts that you cant seem to get. I have had one 15 years no problem have not paid a cent interest. GE money has been around for years which is now Latitude Finance, you are making stories up as we have bought many low price goods on Gem interest Free with not a cent in interest
Stop making false comments about pumped up prices thats just rubbish

Congrats - you're in the small minority who benefit from GEM. Staff at Harvey Norman told us to cut the card in half and never use it. So perhaps if you confined your spending to IO deals it has some merit.

Another one who don't understand how Gem works its a normal Visa card if you spend over $250.00 You get 6 months interest free anywhere in NZ so it does not just apply to Harvey Norman
From what I have seen is people that don't know how GEM works and they can be had up for defamatory comments, all I know that I am getting 6% on money and 12% on property I will use Gems Money with no interest .

Let us not be obtuse and nitpick, different store same concept. Bottomline is there are alterntive credit cards which also offer 6 months IO with half the interest cost of GEM. Case closed.

Yes, they can be used to your advantage, if you are very careful. But I still think people should avoid that card, 25.99% interest? One missed payment and they'll be sucking you dry for months.

Did you not read if you pay on time Gem IS THE BEST THAT WAS MY POINT but if don't yes 25.99% is to much , no pumped prices with GEM as we paid the cash price on products which was on Gem , hey we use the card as charge card and pay on time that was my point without any mumbo jumbo from ill informed people , probably what David HAS MISSED is the HP providers by retailers that don't need plastic, they have huge set up costs each time you want purchase and high rates

The article isn't about HP, its about credit cards, and how the interest rates quoted understate what you will really be paying, if you end up paying them.

if you are over due , or don't pay your balance in full, you lose the interest free period. So if you brought something at the beginning of the month, you'll pay 50 or so days interest straight away.

Yes correct solardb BUT AS I SAID IF YOU PAY IN FULL EACH MONTH it beneficial

Credit cards are awesome, just make sure you pay it off every month. The points on my ASB card used to pay for my mobile phone on a $20 a month plan. Invaluable service when linked to your PayPAL account. Would be hard to function without it these days, but its just about being smart with money.