When you apply for a credit card, you will be presented with a huge amount of information about the credit card that the company legally has to show you before you hit the Submit button. A lot of this information can be very confusing and one of the most important features of a credit card is the purchase rate but what exactly is it and how does it work?
The credit card purchase rate is the interest rate that applies to the balance component that is formed of retail transactions. You only pay this interest if you do not clear your balance in full and this interest rate can vary over time.
Read on to find out more about how the purchase interest rate is charged, what promotional rates mean and what you need to know about the differences between different types of interest rates and balance types.
What is a purchase interest rate on a credit card?
The purchase rate is the interest rate that is applied to the portion of your balance that is made up of retail purchases.
Retail purchases are all the regular types of spend you would normally put onto your credit card. If you pay for something in a shop, go out for a meal in a restaurant or even use your card on the tube, all of these are retail purchases as far as your credit card is concerned.
If you get a credit card and you just use it for everyday spending, you will most likely not have any other type of balance and all of your credit card balance will be classed as purchase balance.
The Financial Services industry often calls these different types of balance "buckets" so the purchase interest rate is the interest rate that applies to the purchase balance bucket.
Most credit cards have a standard purchase rate of 16.9% or 18.9%. If you're not sure what your purchase rate is on an existing card or when you're applying, check the Summary Box document - there will be a table of interest charges and fees and the Purchase Interest Rate will be in that table.
Can the purchase interest change?
The purchase interest rate is a variable rate and is therefore subject to change. In fact, all interest charges on your credit card are variable and your credit card provider can change these at any time.
If the purchase rate on your credit card does change, your credit card company has to notify you in writing at least 30 days before the interest change is applied to your account and you have 60 days from the date on which you receive the letter to opt out of the change.
If you choose to opt out of the change to your purchase interest rate, you will be able to continue paying down your balance at the old interest rate level, but your card will be blocked and you won't be able to use it for any transactions from that point forward.
How is the credit card purchase rate different to the APR?
The credit card purchase rate and the APR are very often confused because they are so closely related to each other. The key thing is to understand how they relate and what's different about them.
The purchase rate is the amount of interest you pay on your retail transactions while the APR (Annual Percentage Rate) is a legally prescribed term that allows customers to compare different credit products by their effective cost.
For the majority of regular credit cards that do not have annual or monthly membership fees, the purchase rate and the APR are exactly the same.
Regulations that govern credit cards prescribe that the APR includes all the costs associated with building and then repaying a set balance and the default assumption used in the calculation is that this balance is made up of retail spend as that is the most common type of transaction.
If there is an annual fee or if credit cards charged a fee for purchases (which they do not unless you're spending abroad), the APR would be higher than the purchase rate because the various fees you have to pay on the card have to be added to the APR calculation. This is why when you see premium credit cards with an annual fee, the APR can often be 80%, 120% or higher - it is all down to the high annual fee skewing the calculation.
Credit card purchase rate vs other types of interest
Credit cards in the UK have 3 or 4 different balance buckets (or types). Some newer cards are trying to simplify this and reduce it to 2 or even 1, but the vast majority of products are sticking with the tried and tested set of balance categories.
The different types of balance are as follows:
|Purchases||Regular spend on your credit card|
|Balance Transfers||Payment off a balance on a different credit card using this credit card|
|Cash withdrawals||Taking cash out from an ATM or over the counter in a bank|
|Money Transfers||A direct transfer of money from your credit card into your bank account|
Virtually all credit cards will do the first 3 of the above and most have all 4 of these balance types (not all offer Money Transfers as a feature).
The purchase interest rate tends to be the lowest of the 4 with Cash and Money Transfers being considerably higher. If you have a standard credit card with a 16.9% purchase rate, the cash interest rate will often be something like 29.9%. The balance transfer interest rate is usually somewhere in-between.
One important thing to note is that when you make payments onto your credit card, these payments have to be allocated to the highest interest balance category by law.
This means that if you have a purchase balance and any other type of balance on a credit card, your payments will be allocated to the other balance type until it is repaid and only then to purchases. This means that your purchase interest will continue being charged despite you making payments, although this does help you pay less interest overall.
Promotional purchase rates and how you should use them
It is much less common to get a promotional rate on a purchase interest rate than it is on balance transfers or money transfers.
This is because purchases are an every day kind of spend and people don't need to much incentive to buy the things they buy already.
Also regular retail spend tends to come over a long period of time in small transactions, one at a time.
Balance transfers and money transfers tend to attract a large amount of spend in one big transaction which credit card companies love because the customers' balances grow more quickly.
Having said that, you can often get good deals on special purchase credit cards when you're applying for a new card. Depending on when you apply and the market situation, you can get deals that offer 0% promotional purchase interest rates for as long as 2 years or even more.
Many people misunderstand how these deals work so check carefully when you apply.
Unlike promotional balance transfer or money transfers, you don't have to do all your spending in the first 2 or 3 months after receiving the card.
The promotional rate will usually apply to all transactions up to the expiry of the promotional rate. After this date the whole purchase balance on your credit card will begin incurring the standard purchase rate.
How the purchase rate gets applied to the credit card balance
The way the purchase rate is applied to your account is another thing that is different to other balance categories.
You may have seen the terminology of "No interest for up to 56 days" or similar used in marketing and in the Summary Box.
What this means is that interest on purchases is not added at the point when you make the transaction. If you repay your credit card in full every month, you will never have to pay a penny of interest on your purchases.
The 56 days bit simply means that if you go out and spend on the first day after your statement is generated, and then pay on the last day you can after the next statement, which will be issued in a month, the maximum amount of time between when you make that transaction and the payment is 56 days.
If you don't repay the balance in full, however, purchase interest will be charged to your transactions from the date you made them and continue being charged until you repay them fully.
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