How Does Credit Card Interest Work?

You probably know that your credit card comes with an interest rate that gets applied anytime you carry a balance on your account.

More and more Americans are carrying a balance: The most recent Quarterly Report on Household Debt and Credit indicates that household debt reached a peak in 2017, and balances on credit cards have climbed 3.1%.

But do you understand how that interest rate actually works?

Your credit card issuer charges you interest anytime you carry a balance on your card beyond a statement's grace period—the time between the end of a billing cycle and when your payment is actually due. The amount of money you are charged is based on your card's interest rate and the average daily balance that you carry.

What Is My Credit Card's Interest Rate?

Almost every credit card comes with an interest rate, known as the annual percentage rate, frequently abbreviated as APR.

This can either be a fixed rate, which means it doesn't change, or a variable rate, which means that it can fluctuate depending on the prime rate, the lowest rate of interest at which money can be borrowed commercially.

Typically, most credit cards come with a variable APR. The current average variable credit card rate is 16.81%, but it can be much lower or higher than that depending on your credit history and the type of card.

A 16.81% annual percentage rate doesn't mean that you will be charged 16.81% on your credit card balance once a year. To understand how much you will actually pay on your credit card debt, you need to know how your card issuer will calculate the interest they assess on your balance.

How Is Credit Card Interest Calculated?

Remember, you are only charged interest on your credit card if you carry a balance from one month to the next. You make purchases in one billing cycle, which is usually anywhere between 28 to 31 days, and then your card issuer generates a monthly statement.

Most cards offer a grace period of at least 21 days in which you can pay off the balance on that statement. If you pay it off in full by the end of that period, you won't accrue any interest charges. But if you don't, the interest will be levied on the balance.

Here's how to calculate how much interest you will be charged:

1. Look up the APR on Your Credit Card

That needs to be converted to a daily rate because your credit card interest is calculated on a daily basis. So you divide the APR by 365 (the number of days in the year).

Let's say your APR is 16%: 0.16 / 365 = 0.00044 is your daily periodic rate.

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 the unpaid balance—the amount of money you have carried over from the previous month's statement.

Next, go through your statement to determine what each day's balance was. Add up each balance amount and divide it by the number of days in your credit card's billing period. That's your average daily balance.

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

Now, you multiply the daily periodic rate calculated in step one by the average daily balance.

Let's say your average daily balance was $1,200: 0.00044 x $1200 = $0.53

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

Finally, you have to multiply the figure from step 2 by the number of days in your billing cycle.

Let's say that's 30 days: $0.53 x 30 = $15.90

So you will be charged $15.90 in interest for this billing cycle.

Your Card May Have Different Interest Rates

One thing to keep in mind is that your credit card may assess different APRs depending on the type of purchase. Make sure you know what your "purchase APR" is—that's the rate that will be assessed on the purchases you make with your card.

You may have a different APR for balance transfers, which is when you transfer the balance from one credit card to another. You may also have an "introductory APR"—a promotional rate offered when you first open a card, for a limited time period.

And if you slip up and make late payments or violate terms of the credit card, you could be assessed a "penalty APR," which is typically the highest rate the issuer will charge.

If you do have to carry a balance, it's vital to always at least make the minimum payments on time so that you don't get bumped up to a higher interest rate and have to pay even more on your debt.

Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.

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