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How Does Credit Card Interest Work

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Jason Steele
Updated August 1, 2022
4 Min Read

If you have a credit card, it has an interest rate. 

A credit card interest rate is measured in APR, or annual percentage rate (APR). This number determines the amount of interest that you pay if you choose to carry a balance on your credit card. If you don’t pay your credit card’s entire statement balance by the due date, then all the charges you made will be subject to interest, based on your account’s average daily balance. 

Credit card companies make money from the interest and fees that they charge you, as well as from fees paid by the merchants that accept credit cards, so they are happy to let you carry a monthly balance. But if you pay off your entire statement balance each month in order to avoid interest charges, you get a valuable service for little expense. Before you sign up for a credit card, you should make sure that you understand the card’s APR and how it works. 

What Is Credit Card Interest?

A credit card interest rate is always expressed as an annual percentage rate (APR). Although APR is an annual rate, credit card companies use it to calculate the interest charged monthly. You can think of this kind of like how speed is often measured in miles per hour, even if the thing that’s being measured isn’t traveling for an entire hour. 

Credit card interest accrues when you don’t pay your full credit card statement balance by your due date. You are assessed interest charges based on your account’s average daily balance after your billing cycle is over.

How Credit Card Interest Works

Whatever is left unpaid on your statement balance by the due date is carried over to the next billing cycle. Any interest incurred during the previous billing cycle is then applied to your new balance. You are responsible to pay for the remaining balance plus the interest amount.

The credit card company multiplies your balance on your credit card by the daily interest rate each day, and then adds that to what you owe. The daily rate is your annual interest rate (the APR) divided by 365, for the number of days in the year. 

If you want to save money on credit card interest, you can reduce your average daily balance as much as possible, by charging less or by paying more. If you are not able to pay the balance in full, pay as much as you can. And you don’t have to wait until the due date to make a payment. You can save money on interest charges by making your payment as early as possible to reduce your account’s average daily balance. You can even make multiple payments each month, as soon as you have access to the funds. 

How Is Credit Card Interest Calculated?

Credit card interest rates are set by the credit card issuer. Variable APR rates are indexed to the Federal Reserve’s prime rate, which is determined based on the federal funds rate as decided by the Federal Reserve Bank. Credit card issuers use the prime rate to determine APRs for their cards. There are several factors that can affect the credit card interest rate that you are actually offered, including your credit score, credit history and credit card type.

When you apply for a credit card, the issuer will perform a hard credit inquiry into your credit report. Your credit report includes things like your credit score, payment history, number of credit accounts, and other information. This information will be used to determine your credit limit and interest rates. The higher your credit score, the lower the interest rate you are usually offered. Premium rewards cards will often have higher interest rates than the rates offered by more basic cards that offer few benefits and no rewards.

Types of Credit Card Interest

There are several types of interest. You could have a credit card with different rates for each type of interest. Most interest rates are variable interest rates, so they change over time based on market conditions. Types of credit card interest include introductory APR, purchase APR, balance transfer APR, cash advance APR, and penalty APR. 

Some credit cards offer introductory APR as an incentive to sign up for the card. Introductory APR offers can be 0%, or a reduced rate of interest on purchases or transfers for a certain amount of time. Purchase APR is the rate applied to purchases that you make with your credit card. 

Balance transfer APR is applied to balances that you transfer from other credit cards and loans, if your credit card allows balance transfers. Cards often also charge a balance transfer fee, which is separate from the balance transfer APR. A balance transfer fee is a fee charged to transfer money from another credit card to this credit card. 

Cash advance APR applies when you use a credit card to borrow money from your credit card. Cash advance interest rates tend to be much higher than other types of interest rates.

A penalty APR can apply when you don’t pay your credit card bill by its due date, typically when your payment is more than 60 days late. Penalty interest rates can also be charged when you violate the card’s terms and conditions. Penalty interest rates are usually the highest APR type.

What Is a Good Interest Rate on a Credit Card?

Although what is considered a good credit card interest rate is subjective to some degree, the average credit card interest rate as of this writing is 16.71%. Therefore, a good credit card interest rate would be below or significantly below this amount. If you have fair or poor credit, you may get a higher interest rate offered on your credit card. This is because the credit card company considers you to be a higher risk for borrowing credit than someone with a higher score. 

However, credit card interest rates vary widely by card and card issuer. So it is a good idea to shop around before applying for a new credit card. When shopping for a new credit card, it is helpful to know your credit score so that you can find out which cards and interest rates you may be eligible for. You can check your credit score through different websites or through some credit card companies.

To avoid paying credit card interest or to minimize the amount of interest you do pay, you should pay your credit card bill in full. If you pay your monthly balance in full, you won’t be charged interest. If you can’t pay your balance in full, pay off as much as you can, but definitely pay the minimum amount to avoid late fees. The minimum payment can be around 3% of the outstanding balance. 

Before signing up for a new card, make sure that you understand how credit card interest works and understand the card’s APR. The card’s specific APR should be available on the credit card issuer’s website. The website should also include the card’s terms and conditions, as well as additional fees.

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