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How Does Credit Card Interest Work?

How Does Credit Card Interest Work?

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This article was last updated Jul 05, 2018, but some terms and conditions may have changed or are no longer available. For the most accurate and up to date information please consult the terms and conditions found on the issuer website.

The interest rate you incur on a credit card is referred to as your APR — annual percentage rate. Since interest rates are listed as annual percentages, simply divided your interest rate by 365 to get your daily interest rate. The most common way you’ll be charged interest on your credit card is when you borrow money to pay for purchases and carry a balance past your payment due date. The interest rate you’re charged typically ranges from the mid-teens to mid-20s, depending on your creditworthiness. In this post, we’ll review the different types of interest rates, how they work, and how you can avoid interest charges.

How to calculate credit card interest

If you want to calculate how much credit card interest you’ll be charged, follow the steps below. For our example we took a credit card with a 23.99% APR, a 30-day billing cycle, and a $1,000 unpaid balance on the card each day.

  1. Convert your APR to find your daily interest rate. Simply, divide your APR by 365.

23.99% / 365 = 0.0657% daily interest rate

  1. Calculate your average daily balance. This can be done by adding up the total unpaid balances for each day of your billing cycle, then dividing by the total number of days in the billing cycle. Your credit card statement will list the days included in your billing cycle as well as your balance on each day.

To make the math easy, we considered someone who carries a $1,000 unpaid balance each day. But that most likely won’t be the case for you — your balance may fluctuate each day. Whatever your balance is for each day in your billing cycle, just add them up. Then divide by the total number of days in the billing cycle to find your average daily balance.

With a $1,000 unpaid balance each day and a 30-day billing cycle, add $1,000 30 times to get $30,000. Then, $30,000 / $1,000 = $1,000 average daily balance.

  1. Calculate the amount of interest you will be charged. Multiply your daily interest rate, your average daily balance, and the number of days in your billing cycle.

0.0657% daily interest rate x $1,000 average daily balance x 30 days = $19.72 interest charge for one billing cycle

Where can I find my interest rate?

Your interest rate will be listed in the “Interest Rates and Interest Charges” table located in your cardmember agreement. There you can find your APR for purchases, balance transfers, cash advances, and penalties.

What are the different types of interest rates?

There are several different types of interest rates listed in your cardmember agreement beyond the standard purchase APR — which is, simply, the standard interest rate you will be charged on new purchases that aren’t paid in full before the end of a credit card’s grace period. Depending on whether or not you carry a balance month-to-month, miss a payment, or take certain actions, you may incur these interest charges.

Here are a few different APRs you may come across:

  • Balance Transfer APR: Most credit cards charge the same APR for balance transfers and purchases, but there may be cards that charge differing APRs. Unlike the APR for purchases, the balance transfer APR will be charged on balance transfers from the purchase date. That means you don’t have a grace period where you can pay your balance transfer off without incurring interest charges — unless, that is, you have a card offering an intro 0% APR period.
  • Introductory APR: You may have a credit card that offers an intro 0% APR for purchases, balance transfers or both. These intro periods allow you to carry a balance without being charged interest for a certain amount of months. For example, you may have an intro 0% for 15 months on purchases and balance transfers. During that time period, you won’t be charged interest on your balance. Once the 15 months end, any unpaid balances will be charged the applicable APR, the regular purchase APR will apply to new purchases and the balance transfer APR will apply to newly transferred balances.
  • Cash Advance APR: If you take out cash from your credit card’s line of credit, that’s considered a cash advance. We don’t recommend taking out a cash advance — the APR associated with a cash advance is often significantly higher than your regular purchase APR. For example, you may have a 16.49% variable APR for purchases, but a 26.49% variable APR for cash advances. Plus, the APR for cash advances takes effect from the date you take out your cash advance — there is no grace period.
  • Penalty APR: If you miss a payment or pay late, you may incur a penalty APR. This rate is often extremely high, near 30%. The penalty APR can be in effect indefinitely, but you may be able to restore your regular purchase APR by making several consecutive on-time payments. Ultimately, it’s up to the issuer and we strongly encourage you to avoid missing payments since the consequences can be steep — especially if you have a large balance.

Can my interest rate change?

Yes, most interest rates are variable — which means they can fluctuate depending on the prime rate. So, if the prime rate increases, your interest rate may also increase. It’s rare to find fixed interest rates which do not change, though some smaller banks may offer fixed interest rates.

What to watch out for: Deferred interest

If you don’t pay your balance in full before the end of an intro period, a credit card issuer may charge you all the interest accrued during the intro period — aka deferred interest.

For example, you may see something like:

  • “No interest if paid in full within six months. Interest will be charged to your account from the purchase date if the promotional balance is not paid in full within six months.”
  • “If the balance is not paid in full by the end of the promotional period, interest charges will be imposed from the purchase date at the purchase rate on your account which is 25.49% APR.”

Tip: While deferred interest is rare among major issuers, lesser known issuers and store cards may charge it. Check the fine print of the “Interest Rates and Interest Charges” section prior to applying for a credit card and make sure to pay your balance in full before the end of a promotional period.

How can I avoid interest charges?

All this talk about interest rates may have you concerned about incurring high fees, but there are steps you can take to minimize interest charges or avoid paying them altogether:

  • Pay your bill on time and in full within your grace period. The only way to avoid interest charges is to pay your bill on time and in full prior to your statement due date. Paying in full before your due date ensures you won’t have unpaid balances that incur interest. Autopay can be a helpful feature to streamline payments, and you can set up payment reminders.
  • Make frequent payments towards your balance. You can make periodic payments towards your bill prior to receiving your statement. This allows you to maintain a lower balance and subsequently reduces the total amount you owe. For example, say your statement (aka billing cycle) closes on the 9th of each month and your bill is due the 1st of each month. You charge a $500 TV on May 15th and plan on purchasing several other big-ticket items before your statement closes on June 9th. If you don’t want one high bill, you can pay for the TV before your statement closes so your bill won’t be as high.
  • If you can’t pay your balance, pay at least the minimum due. Sometimes you may have to carry a balance month-to-month and while this isn’t ideal, you can minimize interest charges by paying at least your minimum due. Not paying your minimum due means you risk being charged a penalty APR and a late fee.

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