How Does Credit Card Interest Work?

What's the Difference Between an Interest Rate and an APR?

The terms "interest rate" and "annual percentage rate" (APR) are often used interchangeably, and in the case of credit cards, they typically mean the same thing. Additional charges such as annual fees, balance transfer fees and cash advance fees aren't figured into a credit card's APR.

With other loans, however, the two aren't necessarily the same. While your interest rate determines how much interest rate you pay on an annual basis for a loan, the loan's APR incorporates all finance-related charges, including origination fees, application fees and more. As a result, an APR on a mortgage, auto or personal loan may be higher than the interest rate you see.

Different Types of APRs on Credit Cards

Credit cards often charge several different types of APRs, depending on how you use them. Here's a quick summary of what you might find.

Purchase APR

This is the interest rate you pay on new purchases you make with your card. Your rate will generally depend on the credit card product itself and your creditworthiness.

Fortunately, credit card companies usually give a grace period on purchases, so if you pay your bill on time and in full every month, you can usually avoid this APR. That said, if you miss a payment or don't pay your bill in full, you may lose your grace period until you pay off the balance.

Balance Transfer APR

A card's balance transfer APR is often the same as the purchase APR and applies only to balances you transfer from other credit cards. There's typically no grace period on balance transfers, and your rate will usually depend on your creditworthiness.

If you make a purchase while a balance transfer APR applies, however, it's important to know that your payments are typically applied to the balance with the highest APR first. So instead of going toward the balance you transferred, your payment could be used to cover the purchase you made before paying down your transferred balance (if purchases carry a different APR from your balance transfer APR).

Introductory APR

Many credit cards offer an introductory low or even 0% APR on purchases, balance transfers or both. With major credit card issuers, these promotions can last anywhere between six and 21 months, depending on the card.

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Cash Advance APR

Typically a set APR, this rate kicks in if you request a cash advance on your account. The cash advance APR is usually higher than the purchase and balance transfer APR, and interest accrues from the date of the transaction.

Penalty APR

A penalty APR, typically the highest interest rate a credit card charges, will typically apply if you miss a payment by 60 days or more on a personal credit card. With some business credit cards, it can occur as soon as you miss a payment. Once you trigger a penalty APR, it'll remain in place for at least six months.

How Is Credit Card Interest Calculated?

There are a few steps to calculating credit card interest, and it can be time-consuming if you don't use an online calculator. However, understanding how the process works can help you know what to expect.

1. Calculate the Daily APR

To do this, divide the APR by 365 (the number of days in the year). So if your APR is 16%, then your daily periodic rate is 0.16 / 365 = 0.00044. Note, however, that some credit card issuers use 360 when determining this rate. You can check with your card issuer to find out which number it uses.

2. Calculate Your Average Daily Balance

Remember, your interest is assessed on your average daily balance. So you have to figure out what that is. To do so, you'll have to look back at your statement.

Start with your balance on Day 1, including any debt you carried over from the previous month. Then, calculate your balance for each day by adding:

• The card's balance at the start of the day
• The day's new charges
• The day's payments and other statement credits
• Fees related to today's transactions

Once you've done this for each day, you'll find the average by totaling each daily balance and dividing the sum by the number of days in the statement cycle.

3. Multiply Your Daily Periodic Rate by Your Average Daily Balance

Now, multiply the daily periodic rate calculated in step one by the average daily balance from step two. Let's say your average daily balance came out to $1,200. The calculation would be: 0.00044 x $1,200 = $0.53.

4. Multiply by the Number of Days in Your Billing Cycle

Finally, you'll multiply your daily interest by the number of days in your billing cycle. If your billing cycle was 30 days, for instance, you'd multiply $0.53 by 30 to get $15.90. You will be charged approximately $15.90 in interest for this billing cycle.

5. Factor In Daily Compounding

Most credit card issuers will compound interest charges daily. In other words, the issuer will add interest charges each day based on your balance from the previous day, then use that to determine your total interest due each month.

Accounting for compounding manually would be extremely time-consuming. Thankfully, the effects of daily compounding are relatively minor over the course of a single month, so you'll get a pretty good estimate with the first four steps in the process.

To better prepare for paying off your credit card balance, you can use Experian's credit card payoff calculator:

Credit card payoff calculator

How to Avoid Paying Credit Card Interest

Credit card interest can be both confusing and expensive, but it's possible to avoid it altogether if you use your card responsibly. Here are some ways you can take advantage of the benefits credit cards offer without dealing with the dangers of credit card interest:

• Pay your balance in full every month. As long as you qualify for a grace period on your purchase, you won't be charged interest if you pay your monthly statement balance in full by your due date. If a card offers a grace period—and most do—it must be at least 21 days. Paying your bill on time will also help you avoid a penalty APR.
• Use an intro 0% APR promotion. If you have to make a large purchase or want to transfer a balance from another credit card, you can avoid interest by getting a card with an introductory 0% APR promotion and paying off the balance before the promotional period expires. Just keep in mind that balance transfers typically incur an upfront fee, which is often 3% to 5% of the transfer amount.
• Avoid costly cash advances. If you need access to cash, consider less expensive options before you turn to your credit card. In addition to a higher APR, you'll also pay a cash advance fee, which can be 5% or more of the advance amount.

The Bottom Line

Credit card interest can be tricky, but there are plenty of ways to minimize or even avoid it altogether. If you're considering a new credit card, Experian's card comparison tool can match you with 0% APR credit cards and other card options based on your credit profile, with no impact on your credit score.