How Credit Card Interest Works
Learn how interest is calculated, how it’s determined, when it’s charged and how to pay less of it
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 have to carry a balance and accrue interest on that balance. So how exactly does credit card interest work? This article will help you answer that question and more—including ways to pay less interest.
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, or APR. For credit cards, the APR and interest rate are usually the same.
When you make a purchase using your credit card, your lender pays the merchant upfront for you. And you eventually pay back your lender by paying your bill. When you pay your bill, you pay back the charge and any interest that has accrued and been applied to the account.
When Is Credit Card Interest Charged?
If you don’t pay your balance in full, then the unpaid portion of your balance is carried over from one billing cycle to the next. This is known as a revolving balance. And revolving balances typically accrue interest. You can reduce the amount of interest you’re charged by paying down more of your revolving balance and by paying it down quickly and on time.
Keep in mind: Interest isn’t only charged on purchases. Interest is also typically charged on transactions like cash advances and balance transfers. And your APR for these types of transactions may be higher than your credit card’s purchase APR. Cash advances and balance transfers may also come with other fees as well. And cash advances generally start to accrue interest immediately.
You can check your credit card’s terms and conditions to find out for sure.
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 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.
The interest rate, or APR, can either be variable or non-variable. A variable APR is often based on the prime rate—an index that most lenders use to set their own interest rates. And a variable APR could change when the prime rate changes. A non-variable APR typically stays the same, but it can change under certain circumstances. For example, your non-variable APR could increase if you make late credit card payments or miss payments, depending on your card issuer’s policy and your card terms.
A credit card may offer an introductory or promotional APR on purchases and balance transfers. After the introductory or promotional period ends, the rate will return to the standard APR disclosed in the card’s terms.
Ways to Pay Less in Credit Card Interest
There are a few ways you can 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. As the CFPB explains, “The higher the balance you carry from month to month, the more interest you pay.”
- 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.
- Use a credit card with a 0% introductory rate. If you need to apply for credit, you could 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.
It doesn’t take a math formula to see that credit card interest charges can become expensive.
Knowing how credit card interest works can help you understand how much it might cost you. But you can reduce the amount you pay in interest by paying your balance in full each and every billing cycle.
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