How does credit card interest work?

Credit cards are great financial tools, but it’s important to understand how they work to use them responsibly. Understanding how credit card interest works is the first step.

If you pay your balance in full each month, you don’t have to worry much about your APR because you won’t accrue any interest. However, that’s not the reality for many people—According to Experian, the average American had $5,315 of credit card debt in 2020.

If you do carry a balance on any of your credit cards, knowing your APR (and how much it’s actually costing you) is important.

In this guide we’ll look at:


What is credit card interest and why does it matter?

You can think of APR as the cost of borrowing money. The credit card issuer covers the cost of your purchases upfront, while you get to pay them back over time. In exchange, they charge you a fee for this service in the form of interest.

Credit card interest is generally described in terms of APR, which stands for annual percentage rate. However, credit card interest is actually calculated on a daily basis and then charged monthly at the end of a billing cycle.

To understand how much a purchase made with your credit card will really cost, you need to understand how interest is calculated and when it is applied. That way, you’ll know exactly how much interest you’ll pay on your credit cards.

For example, if you wanted to pay off a $2,000 purchase over 24 months, you might end up paying closer to $2,400 when you factor in interest charges. This may be worth it to you, or maybe you can be more aggressive with your payments and save, say, $150 in the long run.

Different types of interest

There are many different types of interest, and your credit card may charge different interest rates for purchases, balance transfers and cash advances. Learning about these interest rates will help you understand how credit card interest works—and might help you avoid paying interest on your credit cards.

Fixed interest rate

Fixed interest rates are interest rates that do not change. These interest rates are often associated with mortgages and personal loans—you’ll rarely pay a fixed interest rate on a credit card.

Variable interest rate

Variable interest rates change over time, often in conjunction with the prime rate. Most credit card issuers charge variable interest rates (often called variable APR), which means that your interest rate may go up or down. That said, variable credit card interest rates don’t change that much—a variable purchase APR won’t suddenly jump from 16.99 percent to 29.99 percent, for example. Variable interest rates tend to shift incrementally, and you might not even notice the difference.

Introductory APR

Some credit cards offer 0 percent introductory APR periods, which means that the credit issuer will not charge interest on purchases, balance transfers or both (depending on the offer’s terms) for a designated period. When your 0 percent intro APR offer ends, any remaining balances on the card will begin to accrue interest at the regular APR.

For example, the Citi® Diamond Preferred® Card offers a 0 percent introductory APR on purchases for 12 months and 21 months for balance transfers (followed by a variable 13.74 percent to 23.74 percent APR). Balance transfers must be completed within 4 months of account opening.

The Citi® Double Cash Card offers 18 months of 0 percent APR on balance transfers (13.99 percent to 23.99 percent variable APR thereafter). Any purchases made on your Citi Double Cash Card will earn interest at the regular variable interest rate.

Purchase APR

Your purchase APR is the interest rate associated with purchases made on your card. It may be different from your balance transfer APR and your cash advance APR. Currently, the average credit card APR is around 16 percent—but in many cases, you can avoid paying APR on purchases if you pay off your statement balances in full every month before your grace period expires.

Balance transfer APR

Your balance transfer APR is the interest rate associated with any balances transferred to your card. It may be different from your purchase APR and your cash advance APR. Most of the best balance transfer credit cards offer a 0 percent introductory APR on balance transfers for between 15 and 18 months.

Cash advance APR

Your cash advance APR is the interest rate associated with any cash advances you take on your credit card. Your cash advance APR can be significantly higher than your purchase APR and your balance transfer APR. This is one of the main reasons a cash advance is one of the most expensive ways to use your credit card and why you should carefully consider whether a cash advance is right for you.

Penalty APR

Your penalty APR is the interest rate that your card issuer applies after you miss a credit card payment or make a late payment. Your penalty APR is often much higher than your regular purchase APR, and can last for six months or more. Not all credit cards include a penalty APR, so make sure you read your credit card’s fine print to know whether you’ll be charged a penalty for missed payments.

How credit card interest is determined

Your creditor determines the interest rates for your credit account by looking at your credit history and annual income. When you apply for a credit card, your issuer will do a hard credit inquiry (sometimes called a “hard pull”)  into your credit report. This will allow it to see your credit score, payment history, number of credit accounts and other valuable information about the way you use credit.

Your issuer will use this information to determine whether to issue you a credit card, as well as what your credit limit and interest rates will be. People with higher credit scores usually qualify for lower interest rates. That’s why it can be a good idea to improve your credit score before applying for your next credit card.

According to the Credit Card Act of 2009, credit card issuers are required to give you 45 days’ notice before raising your interest rates (not counting variable interest rate adjustments). Your interest rates might go up if your credit score goes down, for example—or you might miss a payment and get stuck with a penalty APR. Your credit card issuer can also lower your interest rates at any time. A decrease in your interest rates might be related to an increase in your credit score, or it might be linked to a debt management plan.

Learn more: What is a good APR for a credit card?

How to calculate your interest

Many people aren’t familiar with how to calculate credit card interest, but understanding how credit card interest works can help you do the math.

Most credit card interest compounds on a daily basis. This means that your daily credit card interest rate can be calculated by taking your APR and dividing it by 365 (the number of days in a year). This number tells you the amount of interest your issuer charges every day when you carry a balance on your credit card.

Let’s say you have an APR of 16.99 percent. That would place your daily interest rate at approximately 0.05 percent. If your balance at the beginning of your billing cycle is $100, your balance will rise to $100.05 by the end of the day. The next day, you’ll be charged 0.05 percent interest on your new $100.05 balance, increasing your balance to $100.10 (technically, $100.100025). Interest will continue to compound in this way until you reach the end of your billing cycle.

This example assumes that no new purchases have been made during the billing period. Let’s say you add a $25 purchase to your $100.10 balance. That brings your balance up to $125.10, and at the end of the day, you’ll accrue 0.05 percent interest on the entire amount, making your new balance $125.16 (technically, $125.16255).

If this sounds confusing, don’t worry—there are many credit card calculators that will do this math for you. If you want to know how much interest you’ll pay on your credit card if you only make the minimum payment, for example, Bankrate’s minimum payment calculator can help you understand the numbers. If you want to avoid paying interest on your credit cards by transferring the balances to a balance transfer card that offers a 0 percent intro APR, Bankrate’s balance transfer calculator can show you how much money you’ll save.

How to avoid credit card interest

Making a purchase with a credit card has many benefits, especially if you are trying to build your credit or earn rewards. But interest charges could cost you a lot of money over the long term. How do you avoid paying interest rates on your credit card? By taking one simple step: always paying off your statement balance in full. Most credit cards offer a grace period that begins on the last day of your billing cycle and ends on your payment due date. If you pay off your statement balance before your grace period ends, you won’t be charged interest on those purchases.

If you are currently carrying a balance on your credit card, you may need a different solution. Consider transferring your balance to a balance transfer credit card that offers a 0 percent intro APR period. This gives you time to pay off the balance with no interest—so make sure you have a plan for paying off your balance in full before your intro APR period ends.

Once you have your balance back at $0, it’s important to maintain good payment habits to keep interest at bay. Always make sure you have a repayment strategy for any purchases you make, and keep tabs on your billing cycles so that you can make sure you pay off your purchases before your grace period ends.

How to lower your credit card interest rate

There are two ways to lower your credit card interest rate. If you improve your credit score, your credit card issuer might lower your interest rate automatically. This will probably get you a lower interest rate on any new credit cards you apply for, too. The other way to lower your credit card interest rate is by contacting your credit card issuer and asking for a lower interest rate. If you have a history of on-time payments and responsible credit use, you might be able to request a lower rate in exchange for being a responsible cardholder.

If you are struggling with credit card payments, you might be able to get a lower interest rate by contacting your credit card issuer and negotiating a debt management plan. You might also want to consider working with a reputable debt relief company that will contact your credit card issuers and negotiate lower interest rates on your behalf.

The bottom line

Understanding how credit card interest works can help you save money on your credit cards—and it might even help you avoid credit card debt. By utilizing grace periods and balance transfers to avoid paying interest on your credit cards, you can reap the benefits of credit card use without getting stuck with high interest charges.

If you don’t like the interest you’re currently paying on your credit cards, you can work to lower your credit card interest rate by improving your credit score—and if you want to lower your interest rates in order to pay off your debt more quickly, you can contact your credit card issuer to discuss debt management options.