APR – The Real Cost of Credit Card Annual Interest Rate

The real interest rate you pay for your credit card is not the true interest rate quoted by your bank. This is another example of true financial planning.

APR - The Real Cost of Credit Card Annual Interest Rate by CF Lieu - Certified Financial Planner Malaysia
Assume you are one of those who constantly spend more than you earn and frequently misses your payment, putting yourself in Tier 3 bracket of 17.5%.
Say, you have outstanding balance of RM 10,000, so you’ll think (I did previously) that, even if I don’t pay a single cent for the next 12 months, by the 13-th month, I would need to pay 117.5% x 10,000 = RM 11,750. Or, you think, every month, I will be charged a monthly interest of 17.5% /12 = 1.4583%
Not quite that simple. Confused? Let’s solidify the concept with an example below.
Remember, you get your credit card statement monthly – your outstanding balance plus interest incurred previously will be carried forward to the subsequent month. That means, the compounding period is monthly!
In other words, as you are well aware, for the first month, the outstanding balance plus interest incurred is RM 10,145.83. On the second month, the 1.4583% interest will be charged on RM 10,145.83 brought forward from the first month. See the impact of compounding over here?
Effectively, once you want to settle the balance outstanding after the 12th month, you will be paying MORE money than the advertised interest rate of  17.5% due to compounding, because 17.5% is really the APR!
The real interest rate you will be actually paying is the AER. For APR of 17.5%, the AER is 18.974%!! See APR to AER conversion here.  Or in monetary amount, RM 11,897.40 instead of RM 11,750.00
Still don’t believe me? Read this and compute FV in excel with the following inputs: nper = 12 months, 0.014583 for rate and PV = -10,000. Put zero for Pmt. The concept is similar.
So, why banks quoted you 17.5%?

Simple, because it is a lower interest rate between the two. When you are the bank’s debtor, bank need you give you the false impression that you need pay less than you are actually paying than the real interest rate. This is marketing – they are not actually lying to you, just that it’s not the whole truth. You have nothing to blame but your own ignorance.

Different countries have different rules and regulations in place to combat some of the unscrupulous activity surrounding quoting rates that has arisen in the past; however, there is no better insulator against these ruses than proper financial knowledge.

If you know of any bank which quote the real interest rate -AER instead of APR for credit card interests, let me know – I am pretty sure their credit cards product would not be selling too well even though they are telling the truth to customers!

8 thoughts on “APR – The Real Cost of Credit Card Annual Interest Rate”

  1. Good for you Belinda, you sound like an engineer/IT programmer :). Looks like you are in overseas for quite some time already. You should blog about your overseas life, and personal finance experience at your current place.
    Is your friend in actuarial science interested in writing guest posts on the insurance topics? 🙂 . Anyway, I am interested to know more on what you mention about “BNM regulations which guard against over-payment”.
    Cheers, LCF.

    1. Honestly I don’t know where is my actuary friend now, haha. She had earned a lot that she able to take a break for a year and travelled to other part of world without worry her house loan and car loan. You can consult those work in senior position in bank, they should have knowledge about that. 🙂

  2. I’m in Tier3, that said 17.5%interest per annum. The fact is, I never have any outstanding balance every month for many years. I always paid in advance or paid slightly more than what I spent in order to save the online transfer RM2charge (monthly bank saving interest won’t be as much as RM2 anyway) as I was staying abroad all these years. I had read through the credit card policy, technically and programmingly I indeed didn’t meet the requirement for Tier1&2. I should call their customer service one day to clarify, haha.

    1. Hi Belinda, that’s strange…perhaps you don’t use your credit card as often as the bank wants you to? 🙂 I experienced before that one late payment will drop you from Tier 1 back to Tier 3.
      I didn’t get the part where you mentioned, “you didn’t meet the requirement for Tier1 and Tier2” yet you said “you always pay in advance/slightly more than the outstanding balance.” Unless what you mean is…”slightly more than minimum payment” instead of “slightly more than outstanding statement balance”.


      1. My credit card only required me to have at least 12transactions/yr in order to waive the annual fee and it did. I don’t have to make minimum payment since I always pay more than I spent (ie, bank owed me $), so that doesn’t count actually.
        About the Tier1 & Tier2… what I tried to say is the coding in the bank calculating system might not take my kind of payment attitude into consideration. In computer programming, usually goes with this logical format:
        IF you meet A requirements, THEN you get Tier 1,
        IF you meet B requirements, THEN you get Tier 2,
        ELSE Tier 3.
        I assume my case is only minority, one of my friend who is actuary had told me that no bank would like my payment method since they most likely earn less money from me but payment-prompt customer would be essential to their risk management. There are also other Bank Negara regulations guard about this type of over-payment, so I also make sure the difference is reasonable. Anyway, I will be returning to M’sia this year and started changing my payment style in order to enjoy Tier 1 benefit. 🙂

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