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?Here are the top personal loan lenders of 2018!
|Lender||APR Range||Loan Amount|
|1 Includes AutoPay discount. Important Disclosures for SoFi.
2 Includes AutoPay discount. Important Disclosures for Payoff.
3 Important Disclosures for FreedomPlus.
4 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
5 Important Disclosures for LendingPoint.
6 Important Disclosures for LendingClub.
All loans made by WebBank, Member FDIC. Your actual rate depends upon credit score, loan amount, loan term, and credit usage & history. The APR ranges from 6.16% to 35.89%. For example, you could receive a loan of $6,000 with an interest rate of 7.99% and a 5.00% origination fee of $300 for an APR of 11.51%. In this example, you will receive $5,700 and will make 36 monthly payments of $187.99. The total amount repayable will be $6,767.64. Your APR will be determined based on your credit at time of application. The origination fee ranges from 1% to 6% and the average origination fee is 5.49% as of Q1 2017. There is no down payment and there is never a prepayment penalty. Closing of your loan is contingent upon your agreement of all the required agreements and disclosures on the www.lendingclub.com website. All loans via LendingClub have a minimum repayment term of 36 months or longer.
7 Important Disclosures for Earnest.
8 Important Disclosures for Avant.
* The actual rate and loan amount that a customer qualifies for may vary based on credit determination and other factors. Funds are generally deposited via ACH for delivery next business day if approved by 4:30pm CT Monday-Friday. Avant branded credit products are issued by WebBank, member FDIC.
** Example: A $5,700 loan with an administration fee of 4.75% and an amount financed of $5,429.25, repayable in 36 monthly installments, would have an APR of 29.95% and monthly payments of $230.33
* Important Disclosures for Upgrade Bank.
Upgrade Bank Disclosures
** Accept your loan offer and your funds will be sent to your bank via ACH within one (1) business day of clearing necessary verifications. Availability of the funds is dependent on how quickly your bank processes this transaction. From the time of approval, funds should be available within four (4) business days.
|7.73% – 29.99%||$1,000 - $50,000||Visit Upstart|
|6.26% – 14.87%1||$5,000 - $100,000||Visit SoFi|
|6.99% – 35.97%*||$1,000 - $50,000||Visit Upgrade|
|5.99% – 24.99%2||$5,000 - $35,000||Visit Payoff|
|4.99% – 29.99%3||$10,000 - $35,000||Visit FreedomPlus|
|5.99% – 18.99%4||$5,000 - $50,000||Visit Citizens|
|15.49% – 34.49%5||$2,000 - $25,000||Visit LendingPoint|
|6.16% – 35.89%6||$1,000 - $40,000||Visit LendingClub|
|6.99% – 18.24%7||$5,000 - $75,000||Visit Earnest|
|9.95% – 35.99%8||$2,000 - $35,000||Visit Avant|