How does credit card interest work?

Summary

• Credit card interest is the cost of borrowing money from your credit card provider.

• You’re usually charged interest when you carry a balance.
• Interest typically compounds daily, meaning it’s calculated and added to your balance every day.
• You can avoid interest when you pay your full balance every month by the due date.

Credit card interest is the cost of borrowing money. You may be charged interest when you don’t pay your full balance by the due date.

When you pay your entire credit card balance each month, your card provider typically doesn’t charge any interest. That’s because credit cards have a grace period: a timeframe between the end of your billing cycle and payment due date, during which you won’t incur any interest.

Let’s look at how credit card interest works and a few ways to minimize it.

What is credit card interest?

If you’ve ever carried a balance after a big purchase or a surprise expense, you’ve probably seen how interest can add up. Credit card interest is the fee banks charge for carrying a balance on a credit card. It’s usually referred to as the card’s annual percentage rate  (APR), the yearly cost of borrowing money.

Credit card interest is typically compounded daily. That means card providers calculate, and charge interest every day you carry a balance. The way card providers calculate and compound interest can vary.

 

How is credit card interest calculated?

Many card providers calculate credit card interest based on your average daily account balance.¹ With this method, you can divide the APR by 360 or 365 (check your card’s terms) and multiply it by the average daily balance and the number of days in your billing cycle.² Here’s how it works:

1.   Convert APR to a daily interest rate: Divide the card’s APR by 365 to get the daily rate (APR ÷ 365 = daily rate).

2.  Find your average daily balance: Using your credit card statement, add up your unpaid balance for each day of the billing cycle and divide it by the number of days in that billing cycle.

3.  Calculate the interest: Multiply the average daily balance by the daily interest rate and the number of days in the billing cycle.

For example, let’s say you have a credit card with a purchase APR of 20%. Convert that to a daily rate:

20% ÷ 365 = 0.05479%

Let’s also say you have an average daily balance of $2,000. Multiply that by the daily rate and the 30 days in the billing cycle:

$2,000 x 0.05479% x 30 = $32.87 in interest.

What types of interest rates do credit cards have?

Credit cards typically have variable APRs, which can change with market rates. Some cards may offer fixed APRs that stay the same, but those are less common.  Credit cards can also have rates for specific transactions, like:

• Introductory/promotional rates: Some credit cards offer a lower introductory or promotional rate for a limited time on balance transfers, purchases, or both.
• Purchase APR: This rate applies to any purchases you make with your card.
• Cash advance APR: Some credit cards let you borrow part of your limit as cash, usually at an ATM. The APR for these transactions is often higher than for purchases. Cash advances don’t usually come with a grace period, which may mean you start accruing interest immediately.
• Balance transfer APR: This is the interest rate you might pay when you move a balance from one card to another.
• Penalty APR: A card provider might apply a penalty APR if you break the terms of the agreement, such as by making a late payment. Penalty APRs can be significantly higher than your current APR.

How to minimize interest on your credit card

These tips can help reduce your credit card interest.

Pay your balance on time

Late credit card payments can mean being charged late fees and penalty APRs, which can add up. They can also seriously damage your credit.  Pay at least the minimum on time to avoid penalties and credit damage.

Pay your balance in full each month

While on-time payments are essential, paying your balance on time and in full every month can help you prevent interest charges altogether.

Make more than the minimum payment

If you can’t pay your full monthly balance, it can help to pay more than the minimum The more you can pay down your balance, the less interest you’ll accrue.

Take advantage of 0% intro APR offers

Some credit cards offer new cardholders 0% intro APR on balance transfers, new purchases, or both. This offer lasts for a set period. When the period ends, you’ll start incurring the regular APR on any remaining balance.

A 0% intro APR offer for balance transfers can be a good opportunity to transfer and pay down an outstanding balance from another card.

Take charge of your credit card interest

Credit card interest can add up – but by understanding how it works and how to minimize it, you can make smarter decisions about your money. By paying your total balance on time every month and making the most of promotional offers, you can minimize interest and save more.

Looking to learn more? Start by reviewing your credit card’s APR and payment terms. Knowing these details can help you manage your finances more effectively.

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