April 20, 2021

How Does Credit Card Interest Work: ​Understanding Credit Card Interest and Charges

how credit card interest work

The very first concept of credit cards dates back to 1887 by Edward Bellamy in his utopian novel Looking Backward. Since then, they have evolved from being charge cards to modern-day credit cards. As of 2020, Americans have 511.4 million credit cards with $893 billion combined balances in the first quarter. Credit cards indeed are a huge business and people pay for interest rates every single billing. It is important to know how credit card interest work, especially if you’re a cardholder yourself.


What is Credit Card Interest?

Simply put, credit card interest is the cost of borrowing money using a credit card. Since you are given access to credit at any time and within the required limit, the interest is the price you pay. As with any other loan, you are charged interest if you don’t pay off the full balance when the due date comes.

However, unlike loans, you can avoid interest if the card is used the correct way. The key is to always pay the statement balance on or before the due date comes.


What's the Average Credit Card Interest Rate?

Credit card interest rates are determined using Annual Percentage Rate (APR) or the cost you pay each year to borrow money, including fees, expressed as a percentage.

As of May 2020, the average credit card interest rate in the U.S. is 14.52%. However, this includes both interest-charging accounts and accounts that are not assessed interest (promotional 0% APR offers, for example).

If we just consider accounts that are assessed interest, the average interest rate is 15.78%, according to the Federal Reserve. Credit card interest rates are directly tied to the federal funds rate, so they have fallen since the COVID-19 pandemic hit.

Total credit card balances in the United States are $893 billion as of the first quarter of 2020, according to the New York Federal Reserve. This has increased considerably over the past few years but declined a bit in early 2020 as the COVID-19 pandemic hit.

Before the pandemic hit, APR's on credit cards can reach way up to 26.13%.


How to Find Your Credit Card Interest Rate

Your own annual credit card interest rate can be found on your contract or application. In some cases, it is listed as APR and these two terms are interchangeable in terms of credit cards. A rule of thumb: never forget your interest rate, or you might get shocked of the interest payments.

The amount will be expressed as a percentage, and this is how much you'll pay on top of any balance should you not pay off the full amount.


What is APR: Basic Definition

credit card interest

Most credit cards come with interest rates, the price you pay for getting accessible cash anytime. Interest is typically expressed as a yearly rate known as the Annual Percentage Rate, or APR. Though APR is expressed as an annual rate, credit card companies use it to calculate the interest charged during your monthly statement period.

APR tends to be higher and typically doesn't have a grace period. As the Consumer Financial Protection Bureau notes: “If you use your card to get a cash advance, generally you will start paying interest as of the date of the transaction.”


Different Types of Interest and APR

When you receive your credit card contract, it is important to understand and review all the details. This includes the interest rates, penalties, and fees. There are also several types of interest rates and APR's a cardholder must know.


Introductory APR

As a marketing tactic, credit card companies often offer lower interest rates. The temporary promotional APR that some credit card companies offers to get you to sign up. This can apply to purchases and/or balance transfers for a limited time period and is typically lower than the card's regular APR, sometimes even 0%.

Fixed Vs. Variable APR's

Credit cards may have fixed or variable APR. Here’s the difference between the two:

  • A fixed APR typically remains the same, but it can change in certain circumstances, such as if your payment is more than 60 days late or when an introductory offer expires.
  • A variable APR usually changes with the prime rate, as published in the Wall Street Journal. Many variable interest rates start with the prime rate, then add a margin. The result is your variable APR.

Purchase APR

In addition, credit cards have several types of APRs a cardholder must take into consideration. One of which is the Purchase APR. This is the interest rate applied every time you make purchases.

The purchase APR will be used to calculate how much interest you'll pay on an outstanding purchase balance, if you have one. If you have excellent credit (generally, scores of 750 or higher), you may be more likely to qualify for a lower interest rate because a credit card company may consider you a lower-risk customer.

Balance Transfer APR

When you transfer balances from one credit card to another, interest is also incurred. This other type is referred to as the Balance Transfer APR.

Penalty APR

Penalty APR is the interest charged when you make late payments or violate the card's other terms and conditions. This is usually the highest APR, and it may be imposed when your payment is more than 60 days late.

If you have fair or poor credit (generally scores between 550 and 699), you may get a higher interest rate if you're approved for the card. This means it'll cost you more every time you carry a balance with your card, so be sure to pay off your balance on time and in full every month, if possible.

How to Calculate your APR

credit card APR

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

Let's say you have travel rewards credit card and an average daily purchase balance of $1,500 at the end of your 30-day billing cycle. You also have a variable purchase APR of 15.99%.

Here's how to calculate your interest charge (numbers are approximate).

Divide your APR by the number of days in the year.

0.1599 / 365 = a 0.00044 daily periodic rate multiply the daily periodic rate by your average daily balance.

0.00044 x $1,500 = $0.66 Multiply this number by the number of days (30) in your billing cycle.

$0.66 x 30 = $19.80 interest charged for this billing cycle The math requires some work, but the concept is simple: Carry a balance, and you'll pay interest.


Does Every Credit Card Have a Grace Period?

The answer is no. Credit card companies are not required to offer a grace period. Good news, many still do. If your card has a grace period, the issuer must ensure that bills are mailed or delivered at least 21 days before the due date.

Most card issuers give you an interest-free grace period from the date they put together your billing statement until the payment due date. By understanding how credit cards work, you can use your card for purchases and pay them off without incurring any interest. This only applies when you pay in full, though. If you don't, you lose that grace period, and your card issuer can start charging you interest on new purchases immediately. You'll have to pay in full for two billing cycles in a row to get that grace period back.

How to Avoid or Reduce Credit Card Interest Charges

If you want to avoid paying credit card interest charges, or minimize the amount of interest you'll pay in a billing cycle, here are a couple of things you can do.

Pay your Credit Card Bill in Full

It is always good to remember to pay bills on time. As mentioned, not all credit card issuers offer a grace period. They give you at least a 21-day grace period between the purchase date and the payment due date. If you pay off your balance in full and don't have any cash advances outstanding, you won't be charged interest on new purchases made during this interval.

Pay a Little More than the Minimum

When it’s tight, and you can’t pay the statement in full, consider paying off as much as you can to avoid late fees and reduce the overall balance that's subject to interest. The minimum payment is typically up to 3% of the outstanding balance. Anything you pay over this minimum will further reduce your interest charges.


In Summary

Those may be a lot to take in, but it’s quite simple when you understand the basics.


  • Credit cards give you access to cash at any time, given you are spending within the required credit limit.
  • Interest rates are incurred since you are borrowing money. It is also important to understand how the interest works and to identify which types apply to your credit card.
  • The key is to always pay on time and, if possible, in full to avoid penalties and higher interest rates.


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