Credit Cards » Credit Card Guides » How Does Credit Card Interest Work?
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How Does Credit Card Interest Work?

Gaining a deep understanding of how credit card interest work is essential if you want to get the most value from your card. Here's our guide
Author: Baruch Mann (Silvermann)
Baruch Mann (Silvermann)

Writer, Contributor

Experience

Baruch Silvermann is a financial expert, experienced analyst, and founder of The Smart Investor.  Silvermann has contributed to Yahoo Finance and cited as an authoritative source in financial outlets like Forbes, Business Insider, CNBC Select, CNET, Bankrate, Fox Business, The Street, and more.
Interest Rates Last Update: January 1, 2024
The banking product interest rates, including savings, CDs, and money market, are accurate as of this date.
Author: Baruch Mann (Silvermann)
Baruch Mann (Silvermann)

Writer, Contributor

Experience

Baruch Silvermann is a financial expert, experienced analyst, and founder of The Smart Investor.  Silvermann has contributed to Yahoo Finance and cited as an authoritative source in financial outlets like Forbes, Business Insider, CNBC Select, CNET, Bankrate, Fox Business, The Street, and more.
Interest Rates Last Update: January 1, 2024

The banking product interest rates, including savings, CDs, and money market, are accurate as of this date.

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Key Takeaways

  • The Credit Card annual percentage rate, also known as APR, represents an interest rate that customers have to pay to the bank for borrowing funds using a credit card.
  • The interest rates on credit cards are not fixed. The issuer might change the rate, due to several reasons, such as the expiration of the promotional period, changes in credit score or Federal Funds Rate, as well as some other reasons.
  • One way to avoid paying interest on credit cards entirely is to pay the card balance in full before the end of the grace period. This can allow bank customers to save a considerable amount of money on interest expenses.

Carrying a credit card balance can be a massive impediment to financial health. However, there are 0% credit cards that allow you to pay down your debt without incurring interest within the introductory period.

As you can see from this FED Survey of Consumer Finances data chart, the age group that tends to carry the highest credit card balances is the 75 and older age group with $8,000 on average. This is closely followed by the 45 to 54 age group with an average of $7,670.

 

One of the things you need to consider when carrying a credit card balance is the interest rate.  It will affect the cost of carrying a balance on the card and perhaps you would want to minimize or eliminate this cost.

What Is Credit Card Interest?

Credit card interest is a fee charged by credit card issuers when you carry a balance on your credit card from one month to the next. It is calculated as a percentage of your balance, based on an annual percentage rate (APR). The APR is a measure of the cost of credit, expressed as a yearly interest rate.

APR stands for the Annual Percentage Rate and the total annual cost of the credit card on purchases and other transactions that the cardholder makes.  That basic definition is the only simple thing about it.

Your credit rating will probably affect the APR.  Card companies normally give lower costs to those who are financially healthier. However, there are a couple of ways to reduce the interest rate.

If you don't pay your balance in full each month, interest charges will be added. The more you owe on your credit card, the higher the interest charges will be. Over time, these charges can add up and make it more difficult to pay off your balance.

How Does Credit Card Interest Work?

Credit card interest is a fee charged by credit card issuers for borrowing money. Here's how it works:

  • Interest Charges: If you carry a balance on your credit card, interest charges will be added to your balance each month, typically on the billing due date. The interest charges are calculated based on the average daily balance, multiplied by the APR and the number of days in the billing cycle.

  • Minimum Payments Increase Interest Charges: If you only make the minimum payment, it will take longer to pay off your balance and you'll end up paying more in interest charges over time.

It's important to remember that the higher your balance, the more interest you'll be charged. If possible, it's best to pay off your balance in full each month to avoid paying interest charges.

If you can't pay your balance in full, try to make more than the minimum payment each month to pay down your balance more quickly and save money on interest charges

Are Credit Card Interest Rates Fixed?

Keep in mind that APRs are variable, not fixed.  The terms and conditions of your credit card will likely carry a stipulation that provides for the circumstances of a rate rise. 

So keep an eye on things like expiry dates of promotional APRs, late payment APRs, cash advance APRs, etc.  Lenders will have to give notice if they are planning to increase your APR, so be aware of that notice period.

According to the  G.19 consumer credit report from the Federal Reserve, the average interest rate on credit card account is the highest in the last 15 years:

 

How To Find My Credit Card Interest Rate?

You can find your credit card interest rate in several ways:

  • Check your credit card statement: Your credit card interest rate should be listed on your monthly statement, usually near the balance and payment information.

  • Log in to your online account: Many credit card issuers provide online account access, where you can view your account information and details, including your interest rate.

  • Call the customer service number on the back of your card: If you prefer speaking to a representative, you can call the customer service number on the back of your credit card and ask for your interest rate.

  • Review the credit card agreement or terms and conditions: The interest rate should be listed in the credit card agreement or terms and conditions that you received when you applied for the card.

For example, if your credit card discloses an annual percentage rate of, for example, 13%, it doesn’t mean they will charge you 13% interest once a year. 

How you manage your account will dictate whether the effective interest would be higher or lower.  Interestingly, it could even be zero percent.  This is because they calculate the interest on a daily basis and not annually on the amount of debt you carry from month to month.

Card companies will give you a grace period during which you can pay your credit card balance in full so you can avoid paying interest. If you leave any balance beyond the grace period, the company will charge you interest for it in the form of a finance charge.

Types Of Credit Card Interest Charges

There are various distinct sorts of APRs on credit cards that you should be aware of.

  • Purchase APR: The rate of interest charged on purchases made with the card.
  • Penalty APR: When you make late payments or break the card's other terms and conditions, you will be charged interest. This is normally the highest APR, and it may be applied if you are more than 60 days late on your payments.
  • Balance transfer APR: The interest rate charged on a balance transferred from one credit card to another is known as the balance transfer APR.
  • Cash advance APR: The interest rate you pay on the money you borrow using your credit card. This is usually more expensive and does not provide a grace period. 
  • Introductory APR: Some credit card providers offer a special APR to entice you to sign up for their card. For a limited time, this can apply to purchases and/or debt transfers, and it's usually lower than the card's regular APR – occasionally even 0%.
Fed Raises Interest Rates What Does It Mean For Credit Card APR
Fed Interest Rates Increase Affect Credit Card APR (Photo by Doubletree Studio/Shutterstock)

How Is Credit Card Interest Calculated? Example

To calculate how much interest you’ll have to pay, you need to know your average daily balance, the number of days in your billing cycle and your APR.

For instance: you have a travel rewards credit card and you have an average daily purchase balance of $10,000 after your 30-day billing cycle.  Your card has a variable purchase APR of 20 percent. This is how to calculate your interest charge:

  • Step 1: Divide the APR by the total number of days in the year

The APR is %20, which is 0.20. Since we have 365 days a year, the calculation is:

0.20/365 = 0.000547 (daily periodic rate)

  • Step 2:  Multiply the daily periodic rate by your average daily balance

The daily periodic rate is 0.000547 and our balance is $10,000. The calculation for the daily interest is:

0.000547 x $10,000 = $5.47

  • Step 3:   Multiply the daily interest by the number of days in the billing cycle

Let's say we have 30 days, so the calculation for the total interest charged is:

$5.47  X 30 = $164.3 (interest charges for this billing cycle)

You may find the math work a little complicated, but the concept is plain and simple:  Carry a balance and you’ll have to pay interest. Card companies charge different rates but generally, they fall between 1% and 3% per month (this is an APR of 12% to 36%).

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How To Avoid Interest On Credit Card?

If you regularly pay your total outstanding balance by the due date, you won’t have to pay any interest on any purchases.  Some credit card companies extend their offers “up to 56 days interest-free.”

In much simpler English, it means if you buy something on the first day of the new cycle, you have that whole month and then another 25 days to pay it off without interest.

There are several ways to reduce credit card interest payments:

  • Pay more than the minimum payment each month to reduce the balance faster.
  • Transfer your balance to a card with a lower interest rate.
  • Negotiate a lower interest rate with your card issuer.
  • Pay off the card with the highest interest rate first.
  • Avoid taking on new debt while paying off existing debt.
  • Make payments on time to avoid late fees and increased interest rates.
  • Consider a debt management plan or debt consolidation loan to lower interest and simplify payments.

It's important to remember that reducing or avoiding interest charges is just one aspect of managing credit card debt. Developing and following a budget, spending wisely, and paying off the balance in full each month are key steps to achieving financial health.

lower your credit card interest rate
Negotiate with your credit card company to reduce card interest rate (Photo by HAKINMHAN/Shutterstock)

Is There A Quick Way Reduce Interest Charges?

Perhaps the best way of getting around interest charges is by moving your debt between credit cards.  Because of the steep competition among credit cards, many cards have interest-free balance transfer offers – use them to your advantage!  

For example, if you have a $2,000 outstanding balance on a card, find another card that offers 5-6 months interest-free on balance transfers.

By moving your debt to the other card, you could save between $96 and $240.  Just be mindful of balance transfer fees for moving your balance between cards.  Yes, card companies do charge around 2-3% depending on the amount you are transferring and they can add up.  Sit down and do the math first – you may be pleasantly surprised to find that a balance transfer is still a better idea.

Cash Advance Charges Even More Interest

A cash withdrawal transaction using your credit card is very, very expensive! The interest rates for these withdrawals are higher than normal and there is no way to escape them.  On top of that, credit card companies collect a fee for the withdrawal ranging from 1.5% to 3%:

  • High interest rates: Cash advances typically have higher interest rates than regular purchases, meaning you'll pay more in interest over time.

  • Immediate interest charges: Interest on cash advances begins accruing immediately, with no grace period, so you'll start paying interest right away.

  • Cash advance fees: In addition to interest charges, cash advances also come with a fee, which can add significantly to the cost of the advance.

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Credit Card Interest FAQs

most credit card companies give you a grace period. If your credit card issuer offers a grace period, you will not be charged interest on purchases if you pay your entire balance before the due date each month.

If a cardholder does not pay the entire statement balance or makes a late payment, the cardholder has forfeited his or her grace period, and interest charges will normally appear on the next bill. However, cardholders should always review their cardmember agreement for account-specific information.

While it used to be tax deductible, the Tax Reform Act of 1986 stopped allowing tax deductions for consumers on their credit card interest payments. This means that your credit card interest is never tax deductible if you are an individual.

The exception to this is if you have a business card. However, the debt needs to relate to business activity. You will not be able to make personal expense purchases on your company credit card and then claim a deduction for the interest.

Most credit card issuers set a fixed rate for at least a set period. So, you may receive an introductory rate of 2% for the first six months and then the rate will increase.

Most card issuers set their rates as fixed rather than variable, but while this rate won’t fluctuate, if your circumstances change, such as you have missed payments or your credit score drops, the rate may increase.

Most credit card companies compound interest daily. This means the interest you’re charged each day becomes part of the balance that attracts interest on the next day.

However, if you pay your bill in full each month, the interest will not apply to your daily balance. This can help you to save a great deal in charges and fees.

Baruch Mann (Silvermann)

Baruch Mann (Silvermann)

Baruch Silvermann is a financial expert, experienced analyst, and founder of The Smart Investor.  Silvermann has contributed to Yahoo Finance and cited as an authoritative source in financial outlets like Forbes, Business Insider, CNBC Select, CNET, Bankrate, Fox Business, The Street, and more.
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