How Does Credit Card Interest Work?
If you don’t pay off your balances in full each month, you’ll start to accrue credit card interest.
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You need to pay credit card interest if you maintain a revolving balance from one month to the next or take out a cash advance. Commonly referred to as the annual percentage rate (APR), credit card providers calculate your interest using your card’s average daily balance.
Americans pay a significant amount in credit card debt every year, and much of this is interest. According to the data gathered by the Federal Reserve, total credit card debt in the country was at $790 billion at the end of Q2 in 2021.
Knowing your credit card’s APR and how its billing cycles and grace period works can help you save money that you would otherwise pay as interest.
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- Pay off your balances in full each month to avoid paying credit card interest.
- Pay more than the minimum monthly due and as much as you can each month to reduce interest charges.
- Remember that cards that come with 0% intro APR offers start charging interest once the promotional period ends.
How Does Interest Work on a Credit Card?
APR dictates how much interest a borrower is required to pay on carried balances. Your creditworthiness has a bearing on your card’s APR — people with excellent credit scores tend to receive low APRs, while people with low scores get higher rates. People with low scores are given higher interest rates because credit card providers view them as higher-risk consumers.
For mortgages and auto loans, interest rates and APRs are separate charges. However, in the case of credit cards, interest rates and APRs remain the same.
While APR is listed as an annual rate, credit card providers apply interest on average daily balances with a compounding effect. The total amount you need to pay as interest reflects on your credit card statement each month. If you pay the entire outstanding amount before the next billing date, you won’t have to pay any interest.
How to Calculate Credit Card Interest
To calculate interest on a credit card, you need to know your card’s APR and average daily balance.
Monthly Interest Charge Calculation
- Divide your card’s APR by 365 (number of days in a year) to get its daily periodic rate.
- Multiply the daily rate by your average daily balance.
- Multiply this number by 30 (the typical number of days in a billing cycle).
For example, if your card’s APR is 16.99%, you divide 0.1699 by 365. The number you get is approximately 0.00046, which is the card’s daily periodic rate. Multiply this by your average daily balance or current outstanding balance, which, let’s say, is $1,000, and then by 30. That calculation gives you the approximate interest you need to pay for the current billing cycle, or $13.80.
If your card’s APR is 21.99% in the same example, you’ll end up paying around $18.07 as interest for the month.
Note that most credit card providers also apply compound interest, meaning that you’ll pay interest on the principal amount and that interest accumulates with time and attracts further interest. For credit cards, compounding of interest happens every day, and the charge is added to your account the following day.
How to Avoid or Reduce Credit Card Interest Charges
The simplest way to avoid paying interest charges and remain debt-free is to pay off your outstanding balances in full each month before the end of the billing cycle. Alternatively, try to pay as much as you can on your debts each month to reduce the total amount you owe as quickly as possible. The longer you have outstanding credit card debt, the more you pay as interest.
The Grace Period
All new purchases come with a grace period of at least 21 days — as required by the Credit CARD Act of 2009 — during which you won’t be billed interest on the charge. You may make use of this grace period to ensure that your payments get to your card provider on time and avoid or reduce your interest charges.
However, keep in mind that you may not receive the grace period if you didn’t pay off your balance in full after your last billing cycle, have an outstanding amount on a balance transfer or take a cash advance.
Other Ways to Reduce Interest Rate Charges
If you plan to maintain revolving balances, one way to pay less interest is to look for cards with low APRs. Typically, you need excellent credit to qualify for such cards.
If you have outstanding balances on cards with high APRs, you may want to consider a balance transfer card. Such cards come with introductory 0% APR offers on balance transfers for 12–20 months. They may lead to noticeable savings in interest charges, provided you pay your outstanding balances off before the promotional period ends. Any outstanding balance after this period starts accruing interest.
Avoiding paying the minimum monthly payment can help you reduce how much you pay in interest. For example, if you pay the required minimum payment of $150 toward a $5,000 credit card debt, you’ll take 189 months to repay the entire amount and end up paying more than $4,000 in interest. By paying $600 each month, you bring the total interest down to $660 and take only 41 months to repay your debt.
Different Types of Credit Card Interest and APR
Most credit cards come with variable APRs, meaning that the card’s APR is subject to change depending on the prime rate set by the Federal Reserve. Even with cards that charge fixed APR, the APR might change after late or returned payments. It’s also common for cards to apply different APRs to purchases, balance transfers and cash advances.
If you can’t find your card's APR-related information on the card provider’s website, consider looking at the Consumer Financial Protection Bureau’s credit card agreement database. All you need to do is enter the name of your credit card provider and look for your specific card.
- Types of APRsDescription
- Introductory APRIntroductory APRs stay in effect for a set time that typically varies from 12 to 20 months. In most cases, the intro APR is 0%. Once the intro APR period ends, any outstanding balance starts attracting the card’s regular APR. Paying off your balances in full before the offer period ends is the best way to benefit from intro APR offers. The two most common types of introductory APRs are balance transfer APRs and purchase APRs.
- Balance Transfer APRA balance transfer APR applies specifically to balances transferred from other credit cards. Some cards come with 0% balance transfer APR offers for the first 12 to 20 months. These offers can lead to substantial savings if you manage to pay off large balances before the intro period comes to a close. At the end of this period, you’ll have to pay interest toward any remaining amount.
- Purchase APRThe purchase APR refers to the APR that applies to purchases. All purchases come with a minimum 21-day grace period, during which they don’t accrue interest. Some cards come with intro purchase APR offers that allow cardholders to pay no or reduced interest on purchases for a predetermined period.
- Cash Advance APRIdeally, we recommend you steer clear of cash advances. The APR that applies to these is typically noticeably higher than average purchase APRs. Cash advances come with no grace period, and you’ll accumulate interest from the date of your transaction. Another reason it’s best to avoid cash advances is that they tend to come with additional fees.
- Penalty APRCredit card providers may impose a penalty APR if you make a late or returned payment. However, your card provider might consider revising your APR if you make timely payments in the future.
Why Does Interest APR Differ with Normal Purchases, Balance Transfers and Cash Advances?
Credit card providers view cash advances as high-risk transactions, which is why they tend to come with high APRs. In the case of 0% APR balance transfer offers or low APRs on balance transfers, companies tend to provide these to attract new customers. Penalty APRs are put in place to discourage credit card users from making late or returned payments.
"If you are falling behind on credit card interest payments, look into refinancing your credit card debt. You can do this through products like a personal loan or personal line of credit." -- Brett Holzhauer
Other Questions You May Have About Credit Card Interest
This section offers answers to the most commonly asked questions about how credit card interest works.
Limiting how much you end up paying as interest charges can save you thousands of dollars in the long run. Remember, the more you pay toward your outstanding balances each month, the less you pay as interest over time. If you’re using a card for its intro APR offer, make sure you clear all your dues before the promotional period ends.
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About the Author
- Federal Reserve Bank of New York. "Household Debt and Credit Report." Accessed August 20, 2021.
- Federal Trade Commission. "Credit Card Accountability Responsibility and Disclosure Act of 2009 (Credit CARD Act)." Accessed August 17, 2021.
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