Introduction
Credit card interest can be confusing and seem arbitrary if you don’t understand how it is calculated. With interest rates commonly at 20% or higher, carrying a balance can get very expensive very quickly. Fortunately, there are some simple strategies you can use to minimize, or even eliminate, interest charges.
In this comprehensive guide, we’ll explain everything you need to know about how credit card interest works, including:
- What is credit card interest?
- Types of credit card interest rates
- How daily interest is calculated?
- When you pay interest vs. when you don’t
- How to avoid paying interest
- How much you’ll pay in interest based on your balance
- Strategies for paying off credit card balances quicker
We’ll also answer some common questions about credit card interest rates to help clarify any confusion. Arm yourself with knowledge and take control of your credit card balances.
What Is Credit Card Interest?
Credit card interest is essentially a fee that credit card companies charge when you carry a balance from one billing cycle to the next. It compensates them for loaning you money and not being repaid in full each month.
Interest rates are expressed as an Annual Percentage Rate (APR). Despite the name, interest does not necessarily accrue on an annual basis. In fact, credit card interest is usually calculated daily based on your outstanding balance.
The higher your credit card’s APR, the more interest you’ll be charged when carrying a balance. The average credit card interest rate is over 20% APR. However, rates can vary widely depending on your credit score and the type of credit card you have.
READ ALSO: Should You Take Out a Loan to Pay Off Credit Card Debt?
Types of Credit Card Interest Rates
There are several types of credit card interest rates to be aware of:
Purchase APR
This is the standard interest rate charged on all purchases when you carry a balance from one month to the next. Nearly all credit cards have purchase APRs.
Balance Transfer APR
Cards that allow balance transfers may charge a separate interest rate on transferred balances. This may be the same as or different than the purchase APR.
Cash Advance APR
Most cards charge higher interest rates on cash advances, often with no grace period. Cash advance fees also apply.
Penalty APR
If you make a late payment, some credit card companies may hike your interest rate significantly as a penalty. This can be temporary or permanent.
Promotional APR
Introductory 0% APR offers on purchases and/or balance transfers incentivize new card members by deferring interest for 6-18 months. But rates spike afterward, so those balances need to be paid before the promo ends.
Now that you understand the different types of credit card interest rates, let’s look at how that daily interest is actually calculated.
How Is Daily Interest Calculated?
Credit card companies use the following formula to calculate your daily interest owed:
Daily Interest = (APR ÷ 365 days) x Outstanding Balance
This daily interest accrues until you make a payment. Then it is added to your balance. Here is an example of how it works:
- You have a $2,500 unpaid credit card balance
- Your credit card has a 20% APR
- $2,500 x (20% / 365 days) = $1.37 per day
- If you carried this balance for 10 days before making a payment, you would owe $13.70 in interest ($1.37 x 10 days)
As you can see even with a relatively small balance, interest adds up quickly. This is why carrying credit card balances can get very expensive.
When Are You Charged Interest on a Credit Card?
Most credit cards offer an interest-free grace period on purchases. This grace period allows you to pay off new purchases before interest kicks in.
The most common grace period is around 21 days after the end of your billing cycle. However, this varies by card issuer.
You typically lose your grace period when you carry a balance from month to month. At that point, interest starts calculating immediately on new purchases too.
Once you carry a balance, interest accrues daily and compounds until you pay off the full balance. This means you pay interest on interest, causing balances to grow rapidly.
Fortunately, you can regain your grace period by paying off your balance in full and on time for 2 consecutive billing cycles.
READ ALSO: APR vs Interest Rate: What’s the Difference Explained
How Do You Avoid Interest on a Credit Card?
The only guaranteed way to avoid paying interest on your credit card purchases is to pay off your full balance every month by the due date.
If you do happen to carry a balance one month, pay it off ASAP before daily interest snowballs out of control. Consider making bi-weekly payments instead of one large monthly payment to save on interest.
You can also look into applying for a 0% balance transfer offer to pause interest accrual for 6-21 months so you can pay down principal faster. Just be prepared for a balance transfer fee, usually around 3%.
If you consistently pay on time and keep credit card balances low relative to your credit limit, you are more likely to continue qualifying for 0% financing offers and low regular APRs from issuers.
How Much Interest Will You Pay Based on Your Balance?
The amount of interest you’ll pay depends entirely on your average daily balance each month and your card’s APR. Even small purchases can add up to hundreds in interest each year if you only make minimum payments.
Let’s compare how much two consumers would each pay on a $1,000 credit card balance over 1 year:
- Tom has a credit card with a relatively low 12% APR
- Jane has a card with 24% APR (closer to national average)
If Tom and Jane only pay the minimum due each month:
- Tom pays around $120 in interest
- Jane pays around $240 in interest
If Tom and Jane pay $100 per month:
- Tom pays around $55 in interest
- Jane pays around $145 in interest
This shows how a lower interest rate can save substantially on interest charges. Paying more than the minimum due also cuts interest costs dramatically.
Strategies to Pay Off Credit Card Balances Quicker
If you have existing credit card balances accruing interest, here are some proven strategies to pay them down faster:
- Pay more than the minimum payment due each month
- Make bi-weekly payments instead of monthly payments
- Pay off highest-interest debt first using the debt avalanche method
- Consider consolidating multiple balances to a 0% balance transfer card
- Ask issuers to meet/beat offers from competitors for lower rates
- Boost your credit score to qualify for better rates from issuers
- Create a realistic debt repayment plan and budget to follow
Even small changes can save hundreds in interest and eliminate balances years sooner. Shop around for the best terms instead of settling for high interest rates from your current issuers.
To Recap
Understanding exactly how credit card interest works is key to maximizing savings and paying off balances in the most efficient way possible. Small daily interest charges add up substantially over time, especially when making minimum payments.
Fortunately, paying more towards balances each month grants compound interest savings in your favor. Even an extra $20 monthly above the minimum due makes a sizeable difference long term. Transferring balances to a temporarily 0% APR card also minimizes interest costs for a defined period while paying down debt.
Implement even just a couple of the strategies covered in this guide, and you’ll be well on your way to slashing interest payments and becoming debt-free sooner than later. Saving on credit card interest then allows you to focus cash towards more important goals like building savings, investing for the future, and providing for your family.
Frequently Asked Questions (FAQs) About Credit Card Interest
Let’s review answers to some of the most common questions about how credit card interest works:
How is credit card interest calculated?
Credit card companies calculate your daily interest by dividing your card’s APR by 365 days and multiplying it by your current balance. This interest accrues until it’s added to your overall balance.
Do you get charged interest on a credit card if you pay the minimum due?
Yes. Paying only the minimum due does not prevent interest from being charged on the remaining unpaid balance. This interest is added to what you owe the following month.
Can I get a lower interest rate by asking or negotiating with the credit card company?
It never hurts to call your credit card company and ask politely for a lower rate, especially if you have been a long-time customer with excellent payment history. Be prepared to provide evidence of better offers from competitors. Success rates vary widely based on your negotiating skills and credit profile.
What is the average credit card interest rate?
As of November 2022, the average credit card APR is 19.14%, according to Federal Reserve data. But average rates on new offers are often much higher, at 25% or more, based on your creditworthiness. Shop around for the best terms.
What credit card interest rates are considered low?
While over 20% is still quite common, credit cards with APRs 12-15% are generally considered relatively low these days. But make sure to factor fees, perks and other terms into account, not just interest rates.
How much interest can I save by paying more than the minimum due?
Paying more than the monthly minimum, even if it’s just $20 or $50 extra, can lead to substantial interest savings over time. Consider this example:
- Balance Owed: $5,000
- APR: 19%
- Minimum Payment: $100
If you continued paying the minimum due every month ($100), it would take over 7 years to pay off the balance and cost $5,429 total (including $429 interest).
But by paying just $50 extra each month ($150 instead of $100), you would pay off the debt 3 years sooner and save about $2,300 in interest costs. That’s the power of compound interest working in your favor!
What’s the easiest way to avoid paying credit card interest?
The easiest way to avoid credit card interest is to simply pay off your statement balance in full every month by the due date. This allows you to take advantage of a 20+ day grace period on new purchases. If you do carry a balance, prioritize paying that down before spending more.
Can I transfer my credit card balance to avoid interest?
Yes, balance transfer credit cards offer an intro 0% APR for 6-21 months on transferred debt. This gives you over a year to pay off balances interest-free. Just beware of balance transfer fees. Make sure to have a payoff plan prior to the 0% rate expiration date as well to avoid deferred interest.
In another related article, Best No Annual Fee Credit Cards with Rewards and Perks
