Credit Card Interest and Fees

Brendan Harkness

Brendan Harkness

Updated Sep 13, 2016

Though credit cards continue to grow in popularity, few people have a thorough understanding of just how much their cards actually cost them. Even the most careful consumer might be surprised to learn how many fees (some transparent, some unexpected) are associated with a credit card. Generally speaking, two groups feel the pinch of credit card fees: consumers and merchants.

Consumer Credit Card Fees

Application Fee

  • An application fee of $25 or more may be charged when you apply for a credit card.
  • Many credit card issuers do not charge application fees so don’t be shy about asking for this fee to be waived.

Annual Fee

  • Annual fees are common with cards that offer premium benefits such as travel rewards, cash back, merchandize, or gift cards
  • Fees generally range from $15 to $300
  • Annual fees can be a good value if your benefits accrued outweigh the cost of the card. However, it’s always worth trying to negotiate a lower (or no) fee.
Insider Tip: Federal law limits the total fees charged during the first year after you open an account to 25% of the initial credit limit. Credit card companies must also give you 45 days notice before changing certain fees.

Balance Transfer Fee

  • These occur when you transfer balances from one credit card to another.
  • This fee may be a flat dollar amount or a percentage of the amount transferred.

Cash Advance Fee

  • Most credit cards charge a fee for withdrawing cash (a flat fee or a percent of the withdrawal)
  • Use cash advances sparingly because not only will you pay a fee, but interest on the amount starts accruing the minute you obtain the advance

Credit Limit Increase Fee

  • You can potentially trigger this fee if you ask for and receive an increase in your credit limit.

Late Payment Fee

  • Charged when cardholder does not make the required monthly minimum payment
  • There will be a maximum limit, often $25 or $35, if there’s been a late payment in the previous six months.
  • The charge can be added to each billing cycle that is not paid on time.

Returned Payment Fee

  • Charged when the cardholder makes a payment that does not process and needs to be returned
  • There will be a maximum limit, often $25 or $35, if there’s been a returned payment in the previous six months.

Over-the-Limit Fee

  • Charged if you make a purchase that takes your credit card balance over your credit limit.
Insider Tip: Your credit card company cannot allow charges that exceed your credit limit without your permission. If you don’t authorize your credit card company to allow charges that will cause you to exceed your credit limit, your transaction will be declined. If you do authorize charges that will put you over your credit limit, chances are good that you will be assessed a fee for that activity.

Foreign Currency Exchange Fee

  • Some credit companies charge a 2 to 4% surcharge on purchases made in a foreign country/currency

Secured Credit Card Fees

  • Secured credit cards are often used by those with bad or no credit history and must be secured with a cash deposit.
  • These fees can be among the most costly and frequent and may include an application fee, an annual fee, and even a monthly maintenance fee
  • Fees vary widely so confirm your costs before getting a secured card

Swipe (a.k.a Checkout) Fee

It’s not just consumers who have to worry about credit card fees. Most shoppers are blissfully unaware that when we elect to pay with plastic, our purchases aren’t just all profit for merchants.

  • As of Jan, 27 2013, stores in most states are allowed to charge customers paying with a credit card up to an additional 4% of the total purchase price
  • This new fee is intended to offset the fees merchants must pay directly to credit card issuers each time a customer pays with credit
  • Stores adopting the fee are required to post a notice indicating the new charge
  • Avoid the surcharge by shopping at merchants who do not charge the fee (some merchants like Wal-Mart and Target have said they will not impose the surcharge)

How Does Credit Card Interest Work?

The primary method with which credit card issuers make money is in the form of something called “interest income.” Interest income is a fancy way of describing the interest fee that accrues when you don’t pay your credit card balance in full each month.

While most cardholders are familiar with the concept of credit card interest, few understand how interest rates are determined, calculated and how much they can add to your balance. Most cardholders understand, generally, that carrying a balance on their credit cards results in interest, but that’s usually where it ends.

Insider Tip: Avoiding interest is easy! Learn How to Avoid Paying Interest on Credit Cards.

Thankfully that is changing as a result of the passage of the Credit Card Accountability Responsibility and Disclosure Act of 2009 (“CARD Act”), which now requires a clear disclosure of the interest costs associated with carrying credit card debt and making minimum payments.

How the Bank Determines Your Interest Rate

Credit card debt is unsecured debt, meaning there is no asset acting as security for the bank.  As such, credit cards are a risky type of credit for a bank to offer to a consumer. When cardholders make charges and then fail to pay back the money, the bank loses money. As you can imagine, losing money is something the banks want to avoid as much as possible.

Credit card issuers rely heavily upon the credit reports and scores of an applicant to determine the risk of doing business with that individual. If an applicant’s credit is not in great shape, then the card issuer will either turn them down or offer a different card with a higher interest rate.  This helps mitigate the risk of issuing credit to a higher risk individual.

To put the process more simply, consumers with better credit qualify for credit cards with lower interest rates and better terms. Consumers with less than perfect credit will either not qualify for a credit card at all, depending upon the issuing bank’s approval criteria, or may qualify for a credit card with higher interest rates and less favorable terms (i.e. annual fees, monthly fees, deposit requirements, etc.). This process is called risk management.

Calculating Your Credit Card Interest

Credit card interest is referred to as “compound interest,” which means that interest is charged on both the principal (the amount you actually charged) and the accrued interest (the amount the credit card company has already charged you) as well.

Here is an example. If you charge $1,000 on a credit card and you fail to pay the balance off that month, you will then be charged interest, which is then added to whatever balance remains unpaid. Your new balance is the sum of the unpaid balance from the prior month, interest charges, fees (if any), and new charges of merchandise minus payments and credits.

This is an overly simplistic example since it does not factor in the exact payment, which you would have presumably made on the account, but it helps to give you a better idea of how interest is calculated. For every month that you don’t pay your balance in full some amount of interest is applied, which can cause your balance to increase very quickly depending on the interest rate.

The CARD Act Helps

The aforementioned CARD Act has helped to clarify the cost of carrying credit card debt by requiring a clear disclosure of the costs. The next time you get a credit card statement you may notice a box like the one below. This box is required on every credit card statement and has been since 2011.

The information in this “Minimum Payment Warning” is meant to clearly communicate how costly interest can become if you make small payments on your credit card balance and just how long it can take to pay off the debt.

In the example below it would take 18 years from the cardholder to pay off his balance if he just made the minimum payment each month. And, it would cost him $13,755 in interest fees by making only the minimum payment.

Screen Shot 2014-06-13 at 8.23.14 AM

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