How Does Credit Card Interest Work?

Credit card issuers charge interest if you don’t pay your bill in full each month. It’s typically stated as a yearly rate known as the annual percentage rate (APR). To calculate your interest, divide your APR by 365 (days) to get the daily rate, then multiply your current balance by that rate.

There are two types of APRs: fixed APR and variable APR. A fixed APR remains the same unless the introductory rate offer expires or the issuer changes it. A variable APR, on the other hand, changes with the prime rate. Other credit card charges, such as annual fees, foreign transaction fees, and late payment fees, are charged separately. Learn how credit cards work so you can avoid paying additional charges on your credit card bill.

How to Calculate Credit Card Interest

Credit card interest is calculated by converting your annual rate into a daily periodic rate. Aside from your credit card’s APR, you will also need to know your average daily balance during a specific statement period and the number of days in your billing cycle.

For example, let’s say your credit card’s APR is 20%, your average daily balance for a particular statement period is $700, and there are 30 days in your billing cycle.

Here’s how to calculate credit card interest for that example:

1. Divide your APR by 365 (number of days in the year), and you will get your daily periodic rate: 20% APR / 365 = 0.054795%
2. Multiply the daily periodic rate by your average daily balance: $700 (daily balance) x 0.054795% (daily rate) = 38 cents of daily interest
3. Multiply your daily interest number by the days in your billing cycle: 38 cents (daily interest) x 30 days (billing cycle) = $11.40 of interest for this billing cycle

Although APRs vary for each credit card, most credit card issuers use the same method to calculate credit card interest. You can typically find more information about how finance charges are calculated on the back of your statement.

Different Types of Credit Card APRs

Some credit cards charge different APRs for different types of transactions, such as purchases, balance transfers, and cash advances. If you make all of these transactions in one billing cycle, your issuer will calculate your interest using the different APRs and the balance for each transaction type.

The different types of interest and APR are:

• Introductory APR: Some issuers offer temporary promotional APRs to new cardholders. Introductory APRs can apply to purchases and balance transfers, which last for a limited time―usually 18 months or less. Introductory APRs are typically 0%.
• Purchase APR: The interest charged on regular purchases you make on your card.
• Balance transfer APR: The interest charged when you transfer a balance from one card to another.
• Cash advance APR: Cash advance APRs are usually higher compared to regular APRs, and are charged when you withdraw cash from an ATM. Issuers generally charge cash advance APRs on the day of the transaction.
• Penalty APR: Penalty APRs are typically charged when your payment is late for at least 60 days.

Credit card issuers will also consider your credit when assigning APRs. If you have a credit score of 670 or higher, you’re more likely to qualify for favorable interest rates. If your credit score is below 670, you can expect higher APRs.

How to Avoid Credit Card Interest

• Pay your balance in full: The best way to avoid credit card interest is to repay your balance in full monthly. Issuers typically only charge interest on unpaid balances from previous billing cycles.
• Use 0% APR credit cards: Some issuers offer introductory 0% APR credit cards that can help you finance purchases or balance transfers. During this introductory period, you’ll have no interest. Business owners also have an opportunity to access interest-free financing through 0% APR business credit cards.
• Make payments more than once per month: Issuers typically calculate your interest using your average daily balance. By making multiple payments each month, you’re likely to lower your average daily balance, which will result in fewer interest charges.
• Avoid cash advances: Interest on cash advances is typically higher than purchases or balance transfers. To avoid paying interest, you should consider not using your credit card to withdraw cash at an ATM.

Bottom Line

Credit card interest is the price you pay for borrowing money when you use your credit card. Issuers charge interest for your purchases, balance transfers, and cash advances. You can avoid paying interest if you pay your balance in full each month.