The interest charged on credit cards depends on your interest rate and outstanding balance; you can avoid interest entirely by paying your balance in full.
Credit cards deliver great financial freedom by addressing the diverse priorities and lifestyles of different people. They provide a lot of benefits and spending power to cardholders helping them achieve their personal and financial goals. Even with all the benefits accrued from holding a credit card, the interest rate on credit card debt is, 14% at most. Not to mention fees such as cash advance interest, late payment interest, over-limit fee and annual fees. Sounds like a money trap! It’s already tough out here for anybody. Seriously, how is anyone expected to get ahead with that sort of baggage?
Credit Card Interest Rate
Credit card interest is typically expressed as an annual percentage and is the fee paid for the privilege of borrowing money. It is important to note that some banks may choose to calculate interest on the outstanding balance on a monthly basis and others on a daily basis. Since credit cards are a part of day-to-day life for most people, it is important to understand the effects of interest on your personal finance.
How Does Credit Card Interest Work?
Let’s break down the numbers for Wanjiku who has the option to maintain and pay the minimum payment required by the bank or add a little extra on top of her monthly payments.
So let’s assume that the minimum repayment required by the bank is 5% of the total amount billed or KES 500, whichever is higher. Wanjiku is cash-strapped but she can manage to pay an extra KES 5,000 on top of her minimum monthly payments. Each month Wanjiku is charged 14% annual interest on outstanding balances. So, each time Wanjiku makes a payment, part of the payment goes towards paying down the interest and the principal.
The first month of Wanjiku’s credit card debt with the 5% minimum repayment looks like this:
- Principal: KES 500,000
- Payment: KES 25,000 (5% of the remaining balance or KES 500, whichever is higher)
- Interest: [KES 500,000 x 14%] ÷ 12 months = KES 5,833.33 (Simple Interest)
- Principal Repayment: KES 25,000 – KES 5,833.33 = Kes. 19,166.67
- Remaining Balance: Kes. 480,833.33 (Kes.500,000 – $19,166.67)
These calculations are done every month until the credit card debt is paid off. In the end, Wanjiku will have paid KES 650,590 in total over 10.3 years to absolve her of the KES 500,000 in credit card debt. The interest that Wanjiku pays over the 10.3 years totals KES 150,584 higher than the original credit card debt. Not bad.
However, now let’s take a look at how much less Wanjiku will end up paying by simply adding KES 5,000 on her monthly payments.
With an additional KES 5,000 on her monthly payments, Wanjiku now pays a total of KES 596, 901.32 over 3.4 years to absolve the KES 500,000 in credit card debt. Wanjiku ultimately pays KES 90,840 in interest. The extra KES 5,000 saves Wanjiku about KES 59,744 and reduces her repayment period to 3.4 years – that’s a 6.9 years dramatic drop.
How Can You Reduce Your Credit Card Interest Rate?
It is now evident from Wanjiku’s example that any additional payments you make to your credit card debt counts. Her action to pay more than the minimum repayment has resulted in drastically reducing the time and also lead to lower interest charges. Remember, that regardless of the interest on your card, you can reduce the interest rate you’re charged in three ways:
- Paying your balance in full every month (or within the interest-free period) rendering your interest irrelevant as it does not get charged at all.
- Making more than one payment in a month to shrink the overall average daily balance
- And finally, paying more than the minimum repayment like Wanjiku did, if you can’t pay the balance in full.
How is Interest Rate Determined by the Bank?
Interest rates vary from bank to bank whereby an issuer may:
- Have a single interest rate for all customers i.e., 14%, being the cap rate.
- Have a range – for instance, 10% to 14% – your specific rate depends on your creditworthiness.
- Offer a standard rate added on the CBR rate – for instance – an issuer may quote an interest of 4% above the CBR rate.
It is important to note reward credit cards often come with higher rates than a standard card.
Other Fees
Most credit cards agreements have other fees aside from interest such as cash advance interest, late payment interest, annual fee, joining fees and over the limit fees. These fees vary from bank to bank or issuer to issuer.
Cash Advance Interest
A cash advance allows a user to access a short-term loan at the bank or ATM through your credit cards credit line. It is quite convenient for users but also quite expensive.
So why are cash advances so expensive? Here is why:
- Cash Advance Fees. Some banks charge a flat fee per cash advance, while others charge a certain percentage of the amount accessed. Other times, you may find that some banks charge a percentage with a minimum amount – such as 6% or Kes. 1,000, whichever is greater.
- Cash Advance Interest. Interest on cash advances is costly in two main ways: (1) Interest on cash advances starts accruing immediately – no grace periods like what you get for purchases; and (2) Cash advance interest is often higher than the rate charged on purchases.
- ATM or Bank Fees. The financial institution that handles your transaction or the owner of the ATM or bank in which you access the advance will charge a fee too.
All these fees added up, amount to cash advances being quite expensive and not worth it when you have other options such as Mshwari and the like.
Late Payment Interest
Late payment interest is levied when payment doesn’t reach the card issuer before the due date. The interest levied varies across credit cards and depends on outstanding fees. Most local banks charge an interest of 5% of the total outstanding balance.
Late payment of credit card debt has serious consequences to missing a payment or paying late, which result in:
- Raised credit card interest rate to the penalty rate
- The inclusion of the late payment in your credit history and ultimately affecting your credit score
Over-Limit Fee
An over-limit fee is a fee charged when the cardholder’s balance exceeds a prescribed credit limit. Some banks may automatically decline to execute transactions that are over your credit limit, while others give you the option to opt into such transactions and then add hefty fees. Some banks in Kenya may charge a percentage for over-limit fees i.e. 0.5% of the credit limit, while others may charge a flat fee of KES 1,000 or more.
Annual Fee
The annual fee is any fee charged on a yearly (annual) basis. The most common annual fee is the fee charged for simply having the credit card. Some banks charge as much as KES 6,000 for simply holding their card. You are probably wondering why anyone would want to have a credit card with such a high maintenance fee. Well, that’s because cards with high annual fees have bigger rewards – big spenders recognize this as they know they will earn rewards that will outweigh this fee.
Joining Fees
The joining fee is the fee charged upon registration for the credit card which varies from bank to bank and the type of card you have applied for. Some banks don’t charge anything, while others may charge as much as KES 5,000.
What’s Next?
If you must have a credit card in your life then do the following things:
- Find a low-interest credit card
- Avoid interest rate entirely by taking advantage of the interest-free periods
- Getting a lower interest rate on your credit card by paying the balance in full, making more payment within a month or paying more than the minimum repayment required on total balance.
Overall, many Kenyan’s don’t like credit cards because they are afraid of the penalties and the high annual charges. Although credit cards can be bad for your overall financial health, they are great for big spenders as they provide great rewards. The astronomical fees that banks charge simply don’t make sense if you have savings elsewhere. Therefore, if you already have a card, pay all your balances on your credit card as they can get quite costly if sustained for very long periods of time.
Meanwhile, You can click on the following links to read more about debt: