What is credit card interest and how does it work?

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Credit card interest is the cost you pay when you don’t pay off your monthly credit card balance.

Your card's interest rate will vary depending on the card type, the transaction you're trying to make, and your credit score. Often, interest is applied to your remaining balance and accrues daily.

Over time, that unpaid balance and interest grows, leading to higher costs and debt. This can seriously drag your finances — not to mention your credit score. Understanding how credit card interest works can help you use your credit card more responsibly.

What’s the difference between interest and APR?

While the definitions of interest rate and APR differ, the number is the same when it comes to credit cards. Interest refers to the cost of borrowing money, shown as a percentage of the outstanding balance.

APR includes the interest rate plus any associated fees. With other loans, like mortgages, APR will factor in charges like origination fees and points.

But because credit cards don’t have these fees, your card’s APR ends up being the same as its interest rate. Keep in mind some cards do come with fees for late payments, cash advances, or balance transfers, but those fees aren’t factored into APR.

APR is expressed as a yearly rate. An APR of 19.99%, for example, means you’ll pay 19.99% interest over the course of a year if you don’t pay off your balance.

Most cards have a grace period, between the end of a billing cycle and your payment due date, when you can pay your balance without owning any interest.

Looking at APR can help you compare two cards and find the right one. Knowing your card’s interest rate is crucial if you expect to carry a balance.

How to calculate credit card interest

It's helpful to know how much carrying a balance will cost you. To determine how much interest you may get charged, you need to know your card’s interest rate, the number of days in your billing cycle, and your balance.

Here’s how to calculate your card’s interest charges:

1. Divide your card’s interest rate by 365 (the number of days in the year). For example, for a card with 19.99% APR, the daily rate would be 0.0548% (0.1999/365).
2. Next, multiply that daily rate by your balance. If you had a balance of $1,000 on that same card, the interest you’ll charge each day is around $0.55.
3. Multiply the daily interest charge by the number of days in your billing cycle. This will give you a rough estimate of how much you’ll pay in interest each month. Remember that most cards accrue interest daily so that the actual amount will be slightly higher.

While $0.55 per day doesn’t sound like much, that number can add up over time, especially if you have a larger balance.

The average American has a credit card balance of around $6,000. If you carried that balance on a card for 30 days, charging the average interest rate of 20.74%, you’d pay $103.13 in interest. Over the course of the year, with daily compounding, you’d pay close to $1,400 in interest.

Types of credit card APRs to know

Did you know your credit card comes with different APRs? There are a few different types to be aware of.

• Purchase APR: Interest charged on regular purchases when you carry a balance
• Balance transfer APR: Interest rate applied to transferred balance when you transfer a balance from one card to another
• Cash advance APR: If you use your credit card to withdraw cash from an ATM, you’ll face a higher, separate APR that often starts accruing without a grace period.
• Penalty APR: Higher interest rate imposed for late payments or other violations

Your card’s different APRs are listed in your card member agreement, which you can find online.

What’s a good credit card interest rate?

Credit card interest rates are influenced by market conditions and your credit history. While you can’t control the market, you can work on building up your credit score. A strong credit score can help you secure lower interest rates, saving you money in the long run.

The average credit card interest rate is 20.74%, though rates vary widely. Some cards, like store or travel cards, come with higher-than-average interest rates, sometimes over 30%.

Other cards may have an introductory period with 0% APR. But keep in mind that once that period is over, you’ll face a regular interest rate.

Broken down by credit score, here’s what you could have expected to pay in credit card interest in 2020, according to the Consumer Financial Protection Bureau:

• 720 or greater: 12.7%
• 660 - 719: 16.9%
• 620 - 659: 19.1%
• 580 - 619: 20.2%
• 579 or lower: 21.1%

How to reduce the amount of credit card interest you pay

Your goal should be to never pay interest charges, especially on a credit card.

“When you have credit card debt, particularly with a high interest rate, it puts pressure on your household budget, impacting your ability to save and invest for the future,” says Ohan Kayikchyan, a certified financial planner. “Paying off such high-interest debt as soon as possible will free up funds to redirect them toward your saving and investing goals.”

Minimizing the amount of interest you pay is important to your financial health. Credit card interest is high, and the accumulating charges make it hard to get out of debt. These strategies can help you pay the least amount of interest:

• Paying your balance in full and on time to avoid interest charges
• Use interest-free grace periods effectively
• If you’re carrying a balance, try to make more than the minimum payment to reduce your balance faster
• Exploring balance transfer options for consolidating high-interest debt
• Consider low-interest or 0% introductory APR credit cards
• Negotiate with your credit card issuer
• Avoid cash advances

Remember, the best way to minimize credit card interest is to pay your balance in full and on time.

Bottom line

Credit card interest is expensive and can prevent you from reaching your financial goals. It accrues daily, so the sooner you pay it off, the better.

Knowing how much interest you’re paying when you carry a balance is just the first step. Understanding the potential pitfalls of credit cards can help you make smarter decisions and keep more money in your wallet.

Editorial disclaimer: Opinions expressed are author's alone, not those of any bank, credit card issuer, or other entity. This content has not been reviewed, approved, or otherwise endorsed by any of the entities included in the post.