How Credit Card Interest Works (and How to Avoid Paying It)
Credit cards can be useful tools, but their interest rates are among the highest of any common type of borrowing. Understanding how interest is calculated makes it much easier to avoid.
APR and daily rates
Your card's annual percentage rate (APR) is converted into a daily rate, roughly the APR divided by 365. A 24% APR works out to about 0.066% per day. Interest is typically charged on your average daily balance over the billing cycle and compounds, which means interest can be charged on previous interest.
The grace period
Most cards offer a grace period: if you pay your full statement balance by the due date, you are not charged interest on new purchases. This is the key to using a credit card for free. If you carry any balance past the due date, you usually lose the grace period, and new purchases begin accruing interest right away until you pay in full again.
Why minimum payments are costly
Minimum payments are often only 1 to 3 percent of the balance plus interest. On a $5,000 balance at 24% APR, paying only the minimum could take well over a decade and cost thousands of dollars in interest. Your statement is required to show how long minimum payments would take.
How to avoid or reduce interest
- Pay the full statement balance every month.
- If you carry a balance, pay as much above the minimum as possible.
- Consider a 0% balance transfer card, but note the transfer fee and the date the promotional rate ends.
- Call your issuer and ask for a lower rate, especially if you have a good payment history.
- Use a payoff method such as the debt avalanche to target the highest rates first.
Cash advances
Cash advances usually have a higher APR, no grace period, and an upfront fee. Avoid them except in true emergencies.