Credit card interest: How it works and how to calculate it

Credit card interest is a fee charged if there’s an unpaid balance on your account. But if you pay off your credit card’s statement balance by the due date every month, you may not have to worry about interest.

If you find yourself carrying a balance, it may help to understand how credit card interest is calculated. Find out how interest works and a few ways you may be able to avoid or reduce paying interest charges.

What you’ll learn:

• Credit card interest is the cost of borrowing money, typically shown as an annual percentage rate (APR).

• Credit cards typically have variable interest rates, which can vary by transaction type.

• One reason you might be charged interest on a credit card is if the balance isn’t paid in full by the due date each billing cycle.

• Carrying high balances from month to month can result in higher interest charges and affect credit scores.

Credit card interest is a percentage charged on the money you borrow and is applied when you carry a balance. Interest is calculated using the card’s annual percentage rates (APRs), typically calculated daily and compounded over time. That means interest can accrue on top of interest charges you’ve already incurred.

For credit cards, the interest rate and APR are essentially the same and represent the annual cost of carrying a balance. While the APR may include fees on other loan types, a credit card APR generally reflects only the interest charged on your balance.

• Interest rate: The percentage that an issuer charges on a credit card’s balance. On most credit cards, you can avoid paying interest on new purchases by paying your balance in full by the payment due date every month.

• APR: A broader measure that can include interest plus other costs. This can include application, administrative and origination fees, among others. 

This is why APR may be higher than the interest rate for some loans and credit lines.

Credit cards usually have variable interest rates and often apply different APRs to transaction types, such as purchases, balance transfers and cash advances. 

Here’s how they work: 

• Variable-rate APRs: Can change over time based on an index, such as the prime rate, that lenders use to set their rates. Cardholder agreements will state how a variable credit card APR can change over time. 

• Fixed-rate APRs: Less common for credit cards. Despite the name, the rate can still change. But if your issuer changes the rate, they must notify you in advance. Fixed-rate APRs may increase due to late or missed credit card payments, triggering a penalty APR.

• Penalty APRs: Might apply if you make late credit card payments or miss payments altogether. Penalty APRs typically aren’t applied during your credit card’s grace period. Federal law requires issuers to provide 45 days’ notice before charging a penalty APR.

• Introductory APRs: A credit card’s introductory APR, or intro APR, is a promotional interest rate sometimes offered on new cards or for balance transfers. The lower APR may apply to all new purchases or to certain transactions. The rate must remain in effect for at least six months unless the cardholder falls behind on a payment.

• Cash advance APRs: Compared to standard purchases, cash advances could trigger a higher interest rate. Interest typically begins accruing as soon as you request the cash advance.

• Balance transfer APRs: With a balance transfer, the APR is typically applied to the balance you move from one card to another. Balance transfer cards could offer low or 0% promotional APRs. But there can be other costs to consider, such as balance transfer fees.

Generally, issuers charge interest when cardholders carry unpaid balances from the previous billing cycle into the next.

If you carry a balance from one billing cycle to the next, you may still owe interest even if you then pay the new balance in full. You can reduce the interest your issuer charges by paying down your revolving balance and paying it off by the due date.

How exactly credit card interest is calculated varies by issuer. But it’s generally calculated using your average daily balance. Issuers divide your APR by 365 to get the daily interest rate, then multiply it by your balance and the number of days in the billing cycle to determine the interest charged.

The formula looks like this:

Average daily balance ✕ Daily interest rate ✕ Days in billing cycle

Learn more about how to calculate APR on a credit card.

To avoid or pay less interest on credit cards, there are some key strategies that help:

Paying your balance in full by the due date each billing cycle can help you pay less in interest than carrying your balance month after month. If you can’t pay your balance in full, the Consumer Financial Protection Bureau (CFPB) recommends paying as much as possible and at least the minimum credit card payment.

You don’t have to wait until the end of the billing cycle to make a payment. Paying earlier or more than once a month may help reduce interest charges if you carry a balance and don’t pay it off by the due date each month. You might also consider setting up automatic payments to make sure you make your payments on time.

If you need to apply for credit, you might consider applying for a credit card with a 0% introductory APR. Just make sure you know when the introductory period ends. At that point, the APR will increase to the standard APR as disclosed in the card’s terms.

Most credit cards provide a grace period between the end of your billing cycle and your payment due date. Paying your balance during the grace period can help you avoid interest charges.

Still have questions about credit card interest? Consider the answers to these frequently asked questions for more information.

Knowing how credit card interest works can help you understand how much it might cost to carry a balance. You can also reduce or avoid interest charges by paying your statement balance in full and on time each billing cycle. 

If you’re new to credit or searching for your next credit card, Capital One can help: 

• Check out credit cards for building credit.

• Check for pre-approval offers with no risk to your credit scores.

• Earn cash back on every purchase, every day, with a cash back credit card.

• Monitor your credit score with CreditWise. It won’t hurt your credit, and it’s free.