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

If you carry a balance, your credit card's APR will be used to calculate how much interest you will pay on it, so it’s worth understanding this all-important number before you sign up.
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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 many Americans do carry a credit card balance from month to month. According to the Federal Reserve Bank of New York’s Household Debt and Credit Report from the second quarter of 2020, credit card balances stand at approximately $820 billion.

So, what’s the problem with carrying a balance and having credit card debt? In many cases, it boils down to three letters: APR.

Interest and APR: A simple definition

Most credit cards come with an interest rate. Simply put, this is the price you’ll pay for borrowing money.

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 your APR

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

How to 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.

  • 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.

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 can either have 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. This 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%.
  • 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 interest 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.

Where can I find information on my card’s APR?

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

Next steps

Before you sign up for any card, you should …

  1. Know the interest rates and whether they’re fixed or variable.
  2. Understand the factors that can allow your credit card company to change your card’s interest rate.

Note that introductory APR periods don’t last forever. Also, 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.

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 techno… Read more.