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Credit cards come with interest. For people considering applying for or using this type of financing, understanding the basics is key.
By knowing a card's interest rate and how it works, people can choose a credit card that suits their needs and work to avoid the pitfalls of high-interest debt.
But credit card interest rates can be challenging to understand. Credit card interest is expressed as an annual percentage rate (APR) and can vary based on many factors, such as someone's credit score, payment history, and outstanding loans. Each credit card issuer may also have their own criteria for assessing applications and setting interest rates.
The bottom line: If someone carries a balance on their card, they will likely accrue interest each month. This could make it more difficult to pay off debt over time.
This guide explains what credit card interest is, how it works, and potential ways to stay on top of interest charges.
First, the basics: What is credit card interest?
Credit card interest is what people pay to borrow money from their credit card issuer. It's expressed as an APR and generally applied to any unpaid balance on the card.
Credit card issuers usually charge interest if the cardholder doesn't pay their balance in full each month.
When a cardholder gets their monthly credit card bill, they have a few potential options:
If they don't pay their bill in full, the credit card issuer can charge interest on the unpaid balance — even if they make the required minimum payment.
If someone carries a balance from month to month, the interest charges on the credit card can keep adding up (even if they don't make any new purchases). This can potentially make it more challenging to pay off debt over time. That's why it's important to understand a credit issuer's terms and conditions before applying for a credit card and when using a credit card.
Credit card interest can be calculated based on a range of factors. Here are a few that typically go into credit card interest calculation.
Even though credit card interest is determined by an annual percentage rate, it's calculated daily. If someone has a balance on their card, the issuer multiplies that balance each day by a daily interest rate. The daily rate is determined by dividing the APR by 365. At the end of the month, the daily interest is compounded on the credit card statement.
How is the APR itself calculated? It can be based on many factors, including:
It's important to note that before applying for a credit card, a borrower might be given a representative APR by the issuer. Once they apply and enter their information, they'll receive their personal APR. This is the actual APR that will be used for their credit card account.
Average daily balance is a method that credit card companies typically use in tandem with interest rates for total interest calculation.
It's calculated by adding up the outstanding balance for each day and then dividing that total by the number of days in the billing cycle. For example, a total balance of $1,900 divided by 30 days = $633.3.
The average daily balance is usually multiplied by the daily interest rate and then the number of days in a billing cycle to determine total interest charged.
In credit card terms, “days in the cycle” refers to the length of the credit card billing cycle.
This is the period during which cardholders can make purchases with their credit card. At the end of the cycle, the issuer can send a statement that outlines the balance, minimum payment, and due date.
The number of days in the cycle can vary depending on the credit card issuer, but it's typically around 30 days. During this time, any unpaid balance on a credit card can start accruing interest charges.
Can a cardholder avoid paying interest on a credit card? Here are a few examples of how someone may potentially avoid interest charges while using a credit card.
One potential way to avoid interest charges is to pay off the balance in full each month.
If someone is unable to pay off their balance in full, they could at least try to make more than the minimum payment each month. This can reduce the amount of interest charged and may help them pay off the balance more quickly.
Late payments can result in late fees and penalty interest rates, which can increase the amount owed. Paying bills on time each month could help someone avoid these fees and keep interest rates low.
Using credit cards brings potential risks, notably related to credit interest charges. Interest charges can add up and potentially cause difficulty in paying off credit balances. Some associated risks when using credit cards can be:
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