How does credit card interest work?

Young man with books and a laptop open, trying to learn about credit card interestImage: Young man with books and a laptop open, trying to learn about credit card interest

In a Nutshell

Interest on a credit card is the additional amount you’ll accrue on any unpaid balances as determined by your annual percentage rate, or APR. APR can be determined by a myriad of factors, such as credit scores, and can be avoided by paying your balance off on time whenever possible. Read on for more specifics on the different types of APR and how it determines the conditions of your credit card borrowing.
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Between rewards programs and greater financial flexibility, credit cards have a lot to offer. But if you don’t know how credit card interest works, you’ll have a hard time maximizing your card’s benefits.

In an ideal world, you’d never miss a monthly payment or carry a balance on your credit cards. But if you do carry a credit card balance from month to month, you’re not alone. According to the Federal Reserve Bank of New York’s Household Debt and Credit Report from the first quarter of 2023, credit card balances stand at approximately $986 billion.

So, how does carrying a balance lead to an increase in credit card debt? In many cases, it boils down to three letters: APR.

What’s the difference between interest and APR?

Most credit cards come with an interest rate. Simply put, this is the price you’ll pay for borrowing money if you’re unable to pay off your balance in full before the start of the next billing period.

For credit cards, interest is typically expressed as a yearly rate known as the annual percentage rate, or APR. Though APR is expressed as an annual rate, credit card companies use it to calculate the interest charged during your monthly statement period.

How to calculate credit card interest

To calculate how much interest you’ll be charged, you’ll need to know your average daily balance, the number of days in your billing cycle and your APR.

Let’s say you have a travel rewards credit card and an average daily purchase balance of $1,500 at the end of your 30-day billing cycle. You also have a variable purchase APR of 15.99%.

Here’s how to calculate your interest charge (numbers are approximate).

  1. Divide your APR by the number of days in the year.
    0.1599 / 365 = a 0.00044 daily periodic rate
  2. Multiply the daily periodic rate by your average daily balance.
    0.00044 x $1,500 = $0.66
  3. Multiply this number by the number of days (30) in your billing cycle.
    $0.66 x 30 = $19.80 interest charged for this billing cycle

The math for the calculation requires some work, but the concept is simple: Carry a balance, and you’ll pay interest.

How can you avoid or reduce credit card interest charges?

If you want to avoid paying credit card interest charges, or minimize the amount of interest you’ll pay in a billing cycle, here are a couple of things you can do regardless of your credit card’s interest rates.

  • Pay your credit card bill in full. Credit card companies generally give you at least a 21-day grace period between the purchase date and the payment due date. If you pay off your balance in full and don’t have any cash advances outstanding, you won’t be charged interest on new purchases made during this interval.
  • Pay a little more than the minimum. If you can’t pay off your full balance, consider paying off as much as you can to avoid late fees and reduce the overall balance that’s subject to interest. The minimum payment is typically up to 3% of the outstanding balance. Anything you pay over this minimum will further reduce your interest charges.

Does every credit card have a grace period?

No. Credit card issuers are not required to offer a grace period. The good news is that many still do. And if your card has a grace period, the issuer must ensure that bills are mailed or delivered at least 21 days before the due date.

What are the different types of interest and APR?

There are other details in your card’s fine print you should review to understand how much you could pay in fees if you’re not careful. Here’s what you need to know.

A credit card’s APR can either be a fixed APR or a variable APR. A fixed APR typically remains the same, but it can change in certain circumstances, such as if your payment is more than 60 days late or when an introductory offer expires. A variable APR usually changes with the prime rate, as published in the Wall Street Journal. Many variable interest rates start with the prime rate, then add a margin. The result is your variable APR.

Credit cards generally have several different types of APRs that you’ll want to look out for.

  • Purchase APR: The interest rate applied to purchases made with the card.
  • Balance transfer APR: The interest rate applied on the balance transferred from one credit card to another.
  • Cash advance APR: The interest rate applied to the amount of cash borrowed from your credit card. This tends to be higher and typically doesn’t have a grace period. As the Consumer Financial Protection Bureau notes: “If you use your card to get a cash advance … generally you will start paying interest as of the date of the transaction.”
  • Introductory APR: The temporary promotional APR that some credit card companies offer to get you to sign up. An intro APR can apply to purchases and/or balance transfers for a limited time period, and is typically lower than the card’s regular APR — sometimes 0%. Note that introductory APR periods don’t last forever. Additionally, if you pay more than 60 days late, you could be subject to a penalty APR, meaning you’ll be charged higher interest for several months or longer. The good news? If you make six consecutive on-time payments, your credit card issuer may be willing to adjust the rate.
  • Penalty APR: The interest charged when you make late payments or violate the card’s other terms and conditions. This is usually the highest APR, and it may be imposed when your payment is more than 60 days late.

The purchase APR will be used to calculate how much interest you’ll pay on an outstanding purchase balance, if you have one. If you have excellent credit (generally scores of 750 or higher), you may be more likely to qualify for a lower rate because a credit card company may consider you a lower-risk customer.

If you have fair or poor credit (generally scores between 550 and 699), you may get a higher interest rate if you’re approved for the card. This means it’ll cost you more every time you carry a balance with your card, so be sure to pay off your balance on time and in full every month, if possible.

Next steps

Before you sign up for any card, make sure you understand the card’s APR and whether it’s fixed or variable. Additionally, it is important to understand the factors that can allow your credit card company to change your card’s interest rate.

You can find this information and your card’s specific APR on the credit card company’s website. Look for a link to the card’s terms and conditions. You can also read your cardholder agreement to learn more about interest rates and fees.

About the author: Satta Sarmah Hightower is a writer, editor and content marketing manager with a decade of experience in the media industry. Her writing focuses on healthcare, personal finance and technology. Satta has produced sponso… Read more.