How Does Credit Card Interest Work? Find out – and Save More

how does credit card interest work

How does credit card interest work? Most credit card holders understand the basics; they charge a purchase to the credit card, and the credit card company charges interest for the amount borrowed.

But calculating credit card interest actually has its own set of rules and practices that affects how much you pay each month. If you want to understand your credit card debt — and pay your balances down — you’ll need to know how credit card interest works and how much it’s costing you.

How are credit card rates set?

To know how credit card interest works, you’ll need to know your annual percentage rate (APR). This is the rate at which your credit card issuer will charge interest over a year.

The rate you’re offered will be determined by a few things: your creditworthiness, the credit card issuer’s rates on that particular product, and current interest rates.

Your credit score and reports

First, there’s your creditworthiness. This is usually reflected by your credit scores and reports, and reflects how much risk the lender is assuming by giving you credit.

How does this affect your credit rate? Usually, the issuer will list a range of APRs that it offers customers. For instance, it might be 15.99- 21.99% APR. This means that this credit card issuer offers the lower rate of 15.99% APR for applicants with higher scores. Interest rates on the higher range will be applied for those with lower scores.

If your credit score is bad enough, you’ll be rejected for a card altogether.

The type of credit card or issuer

Next is the type of issuer you have. Certain issuers, like credit unions, are more likely to offer low-interest credit cards. Others, like retailers offering store-branded credit cards, will usually charge higher interest rates.

The type of credit card you choose also affects the rate. Credit cards that offer rewards, from airline miles to cash back, will usually charge higher rates. That’s to help offset the costs of their rewards programs.

Today’s credit card rates

Lastly, there are today’s interest rates. Credit card interest rates are variable, which means they can change month-to-month. A variable credit card rate is tied to interest rates in the economy as a whole. If lenders are paying more to borrow money, they will pass those charges on to you. So your credit card interest rate will go up when other key interest rates do.

How does credit card interest work?

When it comes down to it, your credit card interest is a pretty transparent formula. If you understand how your credit card calculates and applies interest charges, you’ll have a more accurate idea of the costs you’re facing.

How to calculate monthly credit card interest charges

Credit card interest is calculated using an “average daily balance.” Your credit card balance changes throughout the month, either because you made an extra payment or added a new charge. The credit card company will look at the average amount you owed each month by adding up the balance recorded each day, and dividing by the number of days in the billing cycle.

For instance, maybe you have a balance of $250 for the first five days. Then you return an item and get a refund from a merchant that lowers your balance to $200. Ten days later, you charge another $200 to the account, bringing your current total to $400. Your credit card company won’t charge interest as if you have a $400 balance the whole month.

Instead, it will average your balance to charge you interest in line with how you managed your credit card balance. In the example above, for instance, the formula might look like this: ($250 x 5 days) + ($200 x 10 days) + ($400 x 15 days) = $9,250 / 30 days in the billing cycle = $308.33 average daily balance.

Calculating monthly credit card interest with your APR

Next, to calculate credit card interest you’ll need to know your monthly credit card interest rate. To find your monthly interest rate, you simply divide your APR by 12, the number of months in a year.

So if your APR is 20%, your monthly interest rate would be 1.67%. Apply that to that average daily balance above of $308.33, and you’d end up with an interest charge of $5.14 for the month’s balance.

Calculating daily interest on credit cards

While the above method can be used to find monthly credit card interest, many issuers will calculate and charge interest daily.

In this case, the APR is divided by the number of days in a year, 365. For a 20% APR, that would be a daily interest rate of about 0.055%. Then this daily credit card rate is applied to any outstanding balance at the end of each day.

So for a balance of $1,000, the daily interest charge at this APR would be $.55. The interest charge is added to the balance, and the next day the process will repeat. So the next day, interest would be charged on the new balance of $1,000.55.

How to pay less interest on credit cards

The great news is that as you figure out how credit card interest works, you’ll be better equipped to avoid it. Here are some tips to avoid on credit cards that only require you to know a little more about how it works.

Don’t carry a balance and avoid credit card interest

One of the best ways to avoid interest on credit cards is to choose not to carry a balance month-to-month. Credit card issuers give a borrower a grace period, at least 21 days, to repay any charges to their account, before they apply interest charges.

If you know your credit card billing dates, particularly when your grace period ends, you can time payments to take advantage of this. Save money by repaying all (or even some!) of the balance by that date, and avoid interest charges.

Make extra payments between monthly statements

Maybe you can afford to repay your balance in full. But if you have some extra funds that you want to apply to a credit card balance, don’t wait until you send in your next full payment.

Paying extra and paying it early in the cycle will help lower your balance. It also means that you’ll have a lower daily average balance on which you’ll accrue interest. Or, if your issuer calculated credit card interest daily, you’ll have more days with a lower balance. It all means you’ll get charged less interest and be that much closer to paying off the balance.

Ask for a lower interest rate.

Don’t assume that your current APR is the one you’re stuck with. You can call your credit card issuer and request a lower interest rate.

If you’ve made responsible, on-time payments on a credit card for a while, cite that as a reason you deserve a lower rate. Or, maybe your credit score has improved since you applied. More often than not, the credit card issuer will help you out by bumping your score down.

Interested in a personal loan?

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LenderRates (APR)Loan Amount 
1 Includes AutoPay discount. Important Disclosures for SoFi.

2 Important Disclosures for Citizens Bank.

SoFi Disclosures

  1. Terms and Conditions Apply: SOFI RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE. To qualify, a borrower must be a U.S. citizen or permanent resident in an eligible state and meet SoFi’s underwriting requirements. Not all borrowers receive the lowest rate. To qualify for the lowest rate, you must have a responsible financial history and meet other conditions. If approved, your actual rate will be within the range of rates listed above and will depend on a variety of factors, including term of loan, a responsible financial history, years of experience, income and other factors. Rates and Terms are subject to change at anytime without notice and are subject to state restrictions. SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers such as Income Based Repayment or Income Contingent Repayment or PAYE. Licensed by the Department of Business Oversight under the California Finance Lender Law License No. 6054612. SoFi loans are originated by SoFi Lending Corp., NMLS # 1121636. (www.nmlsconsumeraccess.org)
  2. Personal Loans: Fixed rates from 5.49% APR to 14.24% APR (with AutoPay). Variable rates from 5.29% APR to 11.44% APR (with AutoPay). SoFi rate ranges are current as of December 1, 2017 and are subject to change without notice. Not all rates and amounts available in all states. See Personal Loan eligibility details. Not all applicants qualify for the lowest rate. If approved for a loan, to qualify for the lowest rate, you must have a responsible financial history and meet other conditions. Your actual rate will be within the range of rates listed above and will depend on a variety of factors, including evaluation of your credit worthiness, years of professional experience, income and other factors. Interest rates on variable rate loans are capped at 14.95%. Lowest variable rate of 5.29% APR assumes current 1-month LIBOR rate of 1.34% plus 4.20% margin minus 0.25% AutoPay discount. For the SoFi variable rate loan, the 1-month LIBOR index will adjust monthly and the loan payment will be re-amortized and may change monthly. APRs for variable rate loans may increase after origination if the LIBOR index increases. The SoFi 0.25% AutoPay interest rate reduction requires you to agree to make monthly principal and interest payments by an automatic monthly deduction from a savings or checking account. The benefit will discontinue and be lost for periods in which you do not pay by automatic deduction from a savings or checking account.

Citizens Bank Disclosures

  1. Personal Loan Rate Disclosure: Variable rate, based on the one-month London Interbank Offered Rate (“LIBOR”) published in The Wall Street Journal on the twenty-fifth day, or the next business day, of the preceding calendar month. As of August 1, 2017, the one-month LIBOR rate is 1.23%. Variable interest rates range from 6.02% – 15.97% (6.02% – 15.97% APR) and will fluctuate over the term of your loan with changes in the LIBOR rate, and will vary based on applicable terms and presence of a co-applicant. Fixed interest rates range from 5.99% – 16.24% (5.99% – 16.24% APR) based on applicable terms and presence of a co-applicant. Lowest rates shown are for eligible applicants, require a 3-year repayment term, and include our Loyalty and Automatic Payment discounts of 0.25 percentage points each, as outlined in the Loyalty Discount and Automatic Payment Discount disclosures. Subject to additional terms and conditions, and rates are subject to change at any time without notice. Such changes will only apply to applications taken after the effective date of change.
  2. Loyalty Discount: The borrower will be eligible for a 0.25 percentage point interest rate reduction on their loan if the borrower has a qualifying account in existence with Citizens Bank at the time the borrower has submitted a completed application authorizing us to review their credit request for the loan. The following are qualifying accounts: any checking account, savings account, money market account, certificate of deposit, automobile loan, home equity loan, home equity line of credit, mortgage, credit card account, student loans or other personal loans owned by Citizens Bank, N.A. Please note, Citizens Bank checking and savings account options are only available in the following states: CT, DE, MA, MI, NH, NJ, NY, OH, PA, RI and VT. This discount will be reflected in the interest rate and Annual Percentage Rate (APR) disclosed in the Truth-In-Lending Disclosure that will be provided to the borrower once the loan is approved. Limit of one Loyalty Discount per loan, and discount will not be applied to prior loans. The Loyalty Discount will remain in effect for the life of the loan.
  3. Automatic Payment Benefit: Borrowers will be eligible to receive a 0.25 percentage point interest rate reduction on their student loans owned by Citizens Bank, N.A. during such time as payments are required to be made and our loan servicer is authorized to automatically deduct payments each month from any bank account the borrower designates. Discount is not available when payments are not due, such as during forbearance. If our loan servicer is unable to successfully withdraw the automatic deductions from the designated account three or more times within any 12-month period, the borrower will no longer be eligible for this discount.
7.39% - 29.99%$1,000 - $50,000Visit Upstart
5.29% - 14.24%1$5,000 - $100,000Visit SoFi
8.00% - 25.00%$5,000 - $35,000Visit Payoff
5.99% - 16.24%2$5,000 - $50,000Visit Citizens
5.99% - 35.89%$1,000 - $40,000Visit LendingClub
5.25% - 14.24%$2,000 - $50,000Visit Earnest
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