How does credit card interest work?

A credit card 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 things can happen, and you may find yourself carrying a balance and accruing interest on that balance. So how exactly does credit card interest work? This article will help answer that question and more—including ways to pay less interest.

Key takeaways

  • Credit card interest is the cost of borrowing money from a lender—typically shown as an annual percentage rate (APR).
  • Credit card interest might be charged if the balance isn’t paid in full each billing cycle.
  • Variable, fixed, introductory and promotional interest rates are a few types of credit card interest.
  • The APR can also vary based on the type of transaction.
  • Paying off the balance in full each month can help cardholders save money on interest in the long run.

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What is credit card interest?

As the Consumer Financial Protection Bureau (CFPB) explains, interest is the cost of borrowing money from a lender. 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.

When is credit card interest charged?

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

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

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, paying it down quickly and paying on time.

Different types of credit card interest

Interest isn’t only charged on credit card purchases. And 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. And a penalty APR might apply if you make late credit card payments or miss payments altogether.

There are a few other types of credit card interest to be aware of too:

Variable rates

Variable-rate APRs can change over time. That’s because variable-rate APRs are typically 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, based on their most creditworthy customer base. Cardholder agreements will state how the card’s variable-rate APR can change over time. 

Any late or missed payments can also cause a variable-rate APR to increase, depending on the card terms.

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.

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 debt or get a lower interest rate, which may help the borrower pay off debt faster.

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 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.

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.

How is credit card interest calculated?

Banks use a formula to determine how much interest you’ll pay on any outstanding balances. The interest can 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, in general, 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 cycle. Then, the total is divided by the number of days in the billing cycle to calculate your average daily balance.

The full explanation of how your issuer calculates interest will be disclosed in your card’s terms and conditions.

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. Luckily, paying off the entire statement balance each billing cycle can help minimize interest charges.

Ways to pay less in credit card interest

There are a few ways to pay less in interest charges. For example, 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. 

Here are a few other ways to pay less in interest:

  • 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 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 in a nutshell

Credit card interest charges can add up. And knowing how credit card interest works can help cardholders understand how much it might cost. Remember, you can reduce interest charges by paying your statement balance in full each billing cycle. 

If you're looking for a credit card and want to weigh your options, Capital One’s credit card comparison tool can help. You can also check whether you’re pre-approved for a Capital One credit card.

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