How does credit card interest work?

Credit card debt is easy to get into and can be hard to climb out of, especially if you’re carrying a big balance on a high-interest credit card.

Behind the allure of the instant purchasing power a credit card can provide is a complex system of interest calculations that can lead to mounting debt. Understanding how credit card interest works is critical for making informed decisions about borrowing and spending. 

What is credit card interest?

Credit card interest fuels the bottom line of banks and financial institutions. Americans paid around $117 billion in credit card interest and fees in 2020, according to the Consumer Financial Protection Bureau. And with credit card interest rates hitting an all-time high in 2023, carrying a large balance month to month can balloon quickly due to compounding interest charges, making it increasingly difficult to pay off that balance and get out of debt.

When you apply for a credit card and are approved, the card issuer will assign you an annual percentage rate (APR) that will be levied on any balance that is not paid in full by the billing statement due date. That APR will most likely be variable, meaning it can rise and fall when the Federal Reserve increases or decreases the federal funds rate.

Interest charges also typically compound daily, meaning you’ll pay interest on both the original balance and any accumulated interest. This compounding of interest charges can make it extremely difficult to pay off a large balance as a percentage of your payment will go toward interest charges instead of all of your payment going toward the principal of your debt. 

Plus, credit cards can have multiple interest rates, depending on how you use your card, such as a regular APR, a higher APR for cash advances (using your credit line to get cash at an ATM) and a penalty rate that applies if you miss payments. We’ll explain in detail below.

That said, know you can avoid interest charges entirely by only charging what you know you’ll be able to pay off in full by the end of each billing statement period, thanks to something known as a grace period. See the section on avoiding interest for more details on that.

Looking for the best debt payoff strategy? Here’s the difference between the debt snowball and the debt avalanche methods.

How does credit card interest work?

Grace period on interest

When you make purchases with a credit card, the card issuer typically offers at least a 21-day grace period after the close of each billing cycle to pay off what you charged on the card without incurring interest charges.

The grace period is the time frame between the close of the billing cycle and the payment due date. But if you don’t pay off the entire balance, you lose that grace period and will be charged interest on the remaining balance plus any new charges you add to the card.

If you used your card for a cash advance there is typically no grace period and interest will start accruing immediately. 

Minimum payment and interest charges

Your monthly credit card statement will reflect your entire balance and any interest charges assessed, as well as the minimum payment amount you will need to pay to keep the account in good standing. 

The minimum payment amount calculation varies among credit card companies, but generally involves a small percentage of the principal of your debt (2% to 4%) plus any interest or fees. If you’ve avoided carrying a balance, your minimum payment will not reflect any interest charges, so the minimum payment may just reflect a portion of your balance. But if you just pay the minimum amount due and leave a balance, then interest charges will start accruing and will be included on your next billing statement.

While paying just the minimum payment due keeps your account in good standing, it can get you in trouble pretty quickly as interest charges start to compound. The Credit CARD Act of 2009 requires all card issuers to include a minimum payment warning chart on every billing statement that breaks down how long it can take to pay off your balance (as well as how much you’ll pay in interest charges) if you just pay the minimum amount due every month.

How to avoid paying credit card interest

The easiest way to avoid paying interest on your credit card charges is to pay the balance off in full every month, which should in most cases let you avoid interest charges due to your credit card’s grace period. If you pay less than the full balance (such as just the minimum due) know that any unpaid balance will start accruing interest after the payment due date has passed. 

Know that if you do carry a balance one month, but pay it off the next month, it may take two billing cycles for any interest charges to stop being assessed.

Also, avoid using your credit card for cash advances since there is no grace period for cash advances and interest accrues immediately.

Another way to avoid interest charges is with a credit card offering a 0% introductory APR period. 

Here’s how a 0% APR period works: For a specified period of time, you won’t incur interest charges for carrying a balance from month to month — depending on your specific card, this promotional period may apply to purchases, balance transfers or both. But any balance that remains on the card after the promotional period expires will accrue interest charges at your card’s regular APR.

How is credit card interest calculated?

When you don’t pay your balance off in full every month, interest charges will accrue on a daily basis, which is broken down into a Daily Periodic Rate (DPR). 

The DPR is your annual percentage rate divided by 365 days in the year. So, if your credit card’s APR is 24.99%, your DPR is 0.0685%. 

That DPR is added to your average daily balance. Your average daily balance is calculated by adding up your daily balances and dividing that total by the number of days in your card’s billing cycle (28 to 31 days depending on the month). 

To illustrate further how interest is calculated, consider the following example of a $5,000 balance on a card with a 24.99% APR (without adding any new charges to the card during a month):

Types of credit card interest

There are a few different types of credit card APRs, depending on how you use the card:

Regular APR: This is the APR you are assigned after you are approved for a card that will apply to purchases made with the card. If you do not pay your entire bill in full by the statement due date every month, any remaining balance will be assessed interest charges according to the calculations illustrated above. And, unless your card offers a low intro rate for balance transfers, any balances you move to this card from a different card will also typically be subject to the regular APR.

Intro APR: If you apply for a credit card that offers a 0% intro APR for purchases or balance transfers — or both — then any eligible balance rolled over during the intro period (which a few cards offer for as long as 21 months) will not be subject to interest charges. However, once the introductory period expires, any balance remaining on the card will immediately begin to accrue interest charges at your card’s ongoing APR in the next billing cycle. It’s also important to know that if your new card offers a 0% intro APR on just balance transfers, you’ll be assessed interest on any purchases you make, and vice versa.

Cash advance APR: Many credit cards charge a higher APR when you use your card to withdraw cash from a bank or ATM. Plus, cash advances accrue interest charges immediately and do not qualify for the regular grace period. And there is also typically a cash advance fee tacked on, generally about $10 or 5% of the amount withdrawn.  

Penalty APR: A penalty APR, often as high as 29.99%, can be assessed on your credit card if you’re more than 60 days late on a payment, if your payment is returned for insufficient funds or if you go over your credit limit. Plus, you’ll likely be assessed a late fee or returned payment fee of up to $41. If you are subject to a penalty APR, the card issuer will send you a notice, generally included with your billing statement, and the penalty APR will apply to your existing balance and any new purchases. If you happen to incur a penalty APR, know that you can revert back to your card’s regular APR on your existing balance if you make six consecutive, on-time payments. However, the penalty APR may still be assessed on new purchases.

What is a good credit card interest rate?

Credit card issuers often advertise a range of APRs for a credit card. For example, the Chase Sapphire Preferred® Card comes with the following APR range: 21.49% to 28.49% variable APR on purchases and balance transfers.

The general rule of thumb is the better your credit score, the more likely you are to qualify for the lower rate. However, you won’t know for sure what your APR will be until you are approved for the card. Issuers will review your credit score as well as other factors, such as income and your credit reports, when deciding which APR you’ll qualify for.

Wondering how good your credit is? Here’s what constitutes a good credit score.

In terms of a good interest rate, everything is relative. One way to look at it is that a good credit card APR is one below the current national average, which was 22.16% (for accounts assessed interest) as of May 2023, per the Federal Reserve. 

However, if you’re new to credit or rebuilding credit, you may find APRs on the cards you can qualify for are much higher than the national average. Don’t let that deter you as having and using a credit card responsibly is one of the best ways to rebuild or build up your credit score — just make small charges to the card that you can easily pay off entirely every month so you’ll build credit while avoiding interest charges entirely.

Also, know that credit unions generally offer credit cards with APRs lower than the national average, which can be helpful if you think you’re going to need to carry a balance once in a while.

Credit card interest vs. APR: What’s the difference?

As they apply to credit cards, interest and APR generally mean the same thing. The APR is expressed as the annual rate and the interest rate you are charged when carrying a balance is broken down into the daily periodic rate, which is your APR divided by the number of days in the year.

The majority of credit card APRs are variable, meaning they rise and fall with Fed rate hikes or cuts. However, you may be able to still find a fixed rate card where the APR is not subject to Fed actions — if you find such a card, it’s likely to be issued by a credit union.

Finally, know that you can avoid interest charges entirely by paying off your entire card balance on time every month.