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

Credit cards can be a great way to make purchases and earn rewards. And if you pay off your credit card’s last statement balance in full every month, you may not have to worry about extra charges—like interest.

But if you find yourself carrying a balance, you may wonder how exactly does credit card interest work? This article will try to answer that question and teach you a few ways you may be able to avoid paying interest.

Key takeaways

  • Credit card interest is the cost of borrowing money, typically shown as an annual percentage rate (APR).
  • Credit cards usually have a variable interest rate, and rates can vary based on the type of transaction.
  • One reason you might be charged interest on a credit card is if the balance isn’t paid in full each billing cycle.
  • Carrying high balances from month to month can result in higher interest charges and affect credit scores.

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What is credit card interest?

Interest is the cost of borrowing money, according to the Consumer Financial Protection Bureau (CFPB). Interest is typically shown as an annual percentage rate (APR). For credit cards, the APR and interest rate are usually the same.

When you make a purchase using a credit card, the lender pays the merchant upfront for you. And you eventually pay back your lender by paying your credit card bill. When you pay your credit card bill, you pay back the charge and any interest that has accrued and been applied to your account, plus any other fees.

What’s the difference between credit card interest and APR?

The terms interest and APR are often used interchangeably, because a credit card’s interest rate and APR are typically the same. But that’s not necessarily the case for other types of credit. 

The main difference between interest and APR is that APR might also reflect other costs, including application fees, administrative fees, origination fees and more. That’s why APR may be higher than the interest rate when it comes to some loans and credit. 

When is credit card interest charged?

If you don’t pay your credit card balance in full, then the unpaid portion of the balance is carried over into the next billing cycle. That’s called a revolving balance. And revolving balances might accrue interest. 

Keep in mind that if you’ve carried 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 amount of interest you’re charged by paying down more of your revolving balance, repaying it quickly and paying off your balance by the due date.

That’s why it’s important to do your research and understand how your credit card works when it comes to paying down your balance.

How is credit card interest calculated?

Banks use a formula to determine how much interest you’ll pay on any outstanding balances. The interest may be calculated daily or monthly, depending on the card.

Some credit card issuers calculate credit card interest based on your average daily balance. If that’s the case with your card, your issuer might track your balance day by day, adding charges and subtracting payments as they’re made. All those daily balances are added together at the end of the billing period. Then, the total is divided by the number of days in the billing cycle to calculate your average daily balance.

If interest is compounded daily, it might also be based on your average daily balance—and then used to determine how much interest you owe at the end of the month. The full explanation of how your issuer calculates interest will be in your card’s terms and conditions.

What are the different types of credit card interest?

Your standard purchase APR isn’t the only interest rate associated with your credit card. A different, sometimes higher, interest rate might be charged for transactions such as cash advances and balance transfers. Cash advances and balance transfers may come with other fees as well. And cash advances generally start to accrue interest immediately. 

A penalty APR might apply if you make late credit card payments or miss payments altogether. For example, a penalty APR might be applied if you don’t meet your card’s terms. This could happen if you miss a payment, if you spend more than your credit limit or if a payment is rejected due to insufficient funds. Penalty APRs typically aren’t applied during your credit card’s grace period. And federal law requires credit card issuers to provide a 45-day notice before charging a penalty APR.

There are a few other types of credit card interest to be aware of too: variable, fixed and promotional or introductory rates. Take a closer look at each below.

Variable rates

Most credit cards these days have variable rates. Variable-rate APRs can change over time based on an index—like the prime rate—that lenders use to set their rates. The prime rate is the interest rate that most commercial banks use to set credit card APRs. Cardholder agreements will state how the card’s variable-rate APR can change over time. 

Fixed rates

Fixed-rate APRs don’t change based on an index, such as the prime rate. But that doesn’t mean a fixed-rate APR will never change. If your credit card issuer does change the rate, they have to notify you beforehand. 

Fixed-rate APRs can change under other circumstances, too. For example, a fixed-rate APR could increase due to late or missed credit card payments, resulting in a penalty APR.

Introductory and promotional rates

Some credit cards may offer an introductory or promotional APR for people who open a new card or complete a balance transfer.

A balance transfer lets cardholders move unpaid debt from one or more accounts to a new or different credit card. It could help consolidate credit card debt or get a lower interest rate, which may help the borrower pay off debt faster. But balance transfers may come with other fees, too, so it’s important to understand the transfer terms before initiating one.

Introductory and promotional rates can vary from one card to another. A card might offer 0% APR or an APR that’s lower than the card’s standard APR. And that introductory or promotional APR might apply to all new purchases made with the card or only certain transactions.

Introductory and promotional interest rates must last at least six months—unless the cardholder is more than 60 days behind on a payment. And once the introductory or promotional APR period expires, the standard APR applies.

How to avoid paying interest on credit cards

If you have a good credit score, you may qualify for a card with a lower interest rate. And a credit card with a low interest rate can help you keep interest costs down if you carry a balance. 

But there are a few ways to pay less in interest charges—or even avoid paying interest altogether:

  • Pay your balance in full every billing cycle. Paying your balance in full every billing cycle can help you pay less in interest than if you carry over your balance month after month. But if you can’t pay your balance in full, the CFPB recommends paying as much as possible—and making at least the minimum credit card payment. As the CFPB explains, “The higher the balance you carry from month to month, the more interest you pay.” Carrying a high balance might also impact your credit scores.
  • Pay as soon as possible. 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’re carrying a balance and not paying your full balance off each month. You might also consider setting up automatic payments to make sure you make your payments on time.
  • Use a credit card with a 0% introductory rate. If you need to apply for credit, you might consider applying for a credit card with a 0% introductory APR on purchases. Just make sure you know when the promotional period ends. At that point, the APR will increase from 0% to the standard APR disclosed in the card’s terms.

Credit card interest FAQs

Still have questions about credit card interest? Take a look at these frequently asked questions for more information. 

Where can I find my credit card’s interest rates?

Your credit card’s interest rates can be found in your account opening disclosures and on your monthly credit card statement.

What determines a credit card’s interest rate?

As the CFPB explains, “The credit card company may decide which interest rate to charge you based on your application and your credit history.” Generally, the higher your credit score, the lower your interest rate might be.

What happens if I carry a balance on my credit card?

Carrying a balance on a credit card from month to month can lead to interest charges. And since interest is charged as a percentage of the credit card’s balance, the larger the revolving balance gets, the higher the interest charges might be. But paying off the entire statement balance each billing cycle can help minimize interest charges.

Do I get charged interest if I pay the minimum?

If you make the minimum payment on your credit card balance, the remaining portion of the balance typically rolls over into the next billing cycle and accrues interest. But you may not be charged interest after making a minimum payment on a card with a 0% introductory rate, as long as you repay the balance in full before the promotional period ends.

Credit card interest in a nutshell

Credit card interest charges can add up, but knowing how credit card interest works can help you understand how much it might cost. You can also reduce or avoid interest charges by paying your statement balance in full each billing cycle. 

Looking for more insights into how you can minimize credit card interest? Check out this guide to lowering your credit card interest rate.

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Dori Zinn, contributing writer

Dori is a personal finance journalist with more than a decade of experience covering credit and debt, college affordability, banking, budgeting, investing, retirement and more. Her work has been featured in dozens of publications, including The New York Times, The Wall Street Journal, Yahoo and Forbes. She loves helping people learn about money.

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