How to Spend Money Wisely » Credit Cards

Does your credit card interest rate matter that much?

One of the items that we’re supposed to look at when choosing a credit card is the interest rate. We’re told that the interest rate is a big deal and that it’s important to get the lowest interest rate possible on a credit card.

But is your credit card interest rate really that important? Well, it depends. Do you carry a balance on your credit card?

Pay off your credit card? Interest rate isn’t as important

On the other hand, if you pay off your credit card each month, the interest rate that you have doesn’t matter as much. If you aren’t carrying a balance, it doesn’t matter how high your interest rate is, because you don’t have a balance for it to be charged on.

This is a good thing because many rewards credit cards come with high-interest rates. So, if you want a rewards credit card, it is often a good idea to make sure you can pay off your credit card each month. Otherwise, the amount of interest that you pay will overset your rewards.

When you are a savvy credit card user, it’s about “gaming” the credit card system. You make planned, regular purchases with your credit card, and rack up the points. Then, because all of your spendings fits in with your budget, you can pay off the card each month. You don’t pay the interest, and you have a lot of points that you can redeem for free stuff or cashback.

Carrying a balance? Credit card interest rate matters

For the most part, your credit card interest rate matters most if you carry a balance on your card. If you carry a balance, the difference between a 15.99% rate and a 19.99% rate matters a lot. The higher your balance, the more it matters. If you carry a balance of $3,000, and it doesn’t go down each month, you would pay $479.70 in interest during the year. That same card at a 19.99% rate, though, will cost you $599.70. That’s a difference of $120.

Credit cards are designed so that if you pay only the minimum on a balance you carry from month to month, you are likely to keep paying on that card for years, and you are likely to pay thousands of dollars in interest. The result is rather discouraging. And the higher your interest, the greater the portion of your monthly payment that goes right to interest, instead of reducing your principal.
When you carry a balance, your interest rate matters. 0% APR credit cards are few and far between in Canada, but it is possible to find low-rate cards that will provide you with a low rate for three to five years so that you can tackle your debt and stop paying so much in interest.

How much does credit card interest cost you?

As long as you pay your balance off each month, you don’t have to worry about credit card interest. And that credit card interest can be a real budget killer. Credit card interest is usually quite high. Canadian credit cards often have higher interest rates than the interest rates seen for credit cards in the United States. This means that Canadians have to be even more careful about not carrying interest.

Even if you are earning rewards on your credit card, they aren’t going to offset the interest you pay. A 2% cashback rewards program can’t compete with 18.99% interest that you pay on a balance carried. Carrying a balance means that you pay interest right into someone else’s pocket. And it costs you big. There are numerous credit card interest calculators online that can show you exactly how much interest you pay each month on a carried balance — and it’s not pretty.

You should also consider the impact of lost opportunity on your finances. If you are paying interest straight to someone else, you are losing the use of those financial resources. What if, instead of paying interest and receiving nothing in return beyond the privilege of borrowing money, you invested that money. Your money could be earning compound interest. You can’t replace the time that your money could have been working on your behalf.

Paying the minimum balance

If you are serious about getting out of credit card debt, you need to do more than just pay the minimum balance. When you pay the minimum balance on a credit card, most of your payment goes toward the interest you have been charged for the month. Very little of your payment goes toward reducing the principal.

Your credit card minimum payment isn’t designed to help you pay off your debt in the shortest period of time. Instead, it’s designed to make the most of the interest that you pay. When you pay only the minimum payment, it can take years to pay off your credit card. On top of that, the amount of interest that you pay can amount to up to three times — or more — than what you originally borrowed.

Paying interest like this saps your own financial resources, and it means that you miss out on opportunities to improve your money situation.

Your credit card is a tool, use it wisely

Credit cards can be great financial tools. However, you have to plan your usage. Make sure that your purchases are items that you have already planned to buy. Then, make sure you have enough money to pay off the balance each month. That way, you will be able to make full use of credit cards, without losing money to interest.

Your financial situation dictates how important interest rates on credit cards are to you. As long as you are smart about your credit card use, and pay off the balance each month, the interest rate on the card isn’t such a big deal. You can go for a good rewards card with a higher rate, and not worry about it.

Comments

  1. Lance @ Money Life and More

    I never carry a balance and only use credit cards for the rewards so they could charge 29% interest and I wouldn’t care because I would never pay a cent of interest to the credit card 🙂

  2. Frugal Grugal Guy with Balance

    Don’t even know the interest rate is the credit card company charges that I deal with. I get my 1% on everything I purchase.

    The most important part of my comment is I pay my credit card in FULL every month. Paying over 20% or whatever the number is does not makes good financial sense.

    No one pays me those interest rates on my money so I am never going to pay a credit card company those rates.

  3. Cherleen @ My Personal Finance Journey

    Since we paid off and closed the rest of our credit cards, we never carried a balance with our credit card anymore. We learned how to play the credit card game and made sure that we do not carry a balance so that we will not pay any interest.

  4. Suzan

    Indeed, if you have credit card debt, the interest you pay is super important! It is far too easy to fall into a credit card debt trap. By making only minimum payments, which many Americans do, you will end up paying so much more and constantly be risking your credit score. Paying with cash or paying off your credit card debt in full is so much more advantageous.

  5. jane savers @ solving the money puzzle

    I don’t carry a balance so I don’t pay interest. I have 3 cards and none have a yearly fee.

    Too bad I don’t make the 60K per year to qualify for the premium cards with the higher rewards level.

  6. Tomasz Gorski

    A well researched post indeed. Credit cards are always very useful as a finance resource; only thing you need to know is how to use it effectively.

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