How Does My Credit Card Interest Work?
According to a 2014 Gallup poll, about half of American credit card users sometimes carry a balance on their cards.1 If you’re one of those millions of users, you’ve almost certainly noticed interest charges on your monthly card statement.
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Do you have questions about how these charges are calculated? Remembering just a few facts about credit card interest will empower you to make the best financial decisions for yourself and your family. Here’s what you need to know:
What is my interest rate?
Your credit card purchases are subject to a standard interest rate called the Annual Percentage Rate, or APR. This number will vary from card to card and person to person depending on factors such as credit scores. Your APR is expressed in terms of a year, but credit card companies use it to calculate charges over your monthly statement period. So just like “miles per hour” is a way of measuring speed over an hour, APR measures interest over the time period of a year. But in both cases, the measurement can still be used for longer or shorter time periods.
How is it calculated?
To find out how much interest you’re paying on your balance each day, you can convert your APR to a daily percentage rate. To do so, divide your APR by 365, the number of days in a year. At the end of each day, the card issuer will multiply your current balance by the daily rate to come up with the daily interest charge. That charge is then added to your balance the next day, a process called compounding.
If your credit card has an APR of 15%, it will have a daily rate of .041096%. Let’s say a cardholder has a balance of $1,000 at the 15% APR standard interest rate. The next day, interest is added and the balance becomes $1,000.41, plus any additional purchases and minus any new credits or payments. This process occurs each day until the end of the cardholder’s monthly statement cycle. So at the end of the month, the beginning $1,000 balance becomes $1013 when interest charges are applied at 15% APR.
When is the best time to pay?
Here’s a great secret about credit card interest: credit card companies usually grant you a grace period. If a grace period applies, the credit card issuer will not charge you interest on purchases if you pay your entire balance by the due date each month.
However, if a cardholder fails to pay the entire statement balance, or does not make the payment in time, the cardholder has forfeited his or her grace period, and the interest charges will typically appear on the next statement. But cardholders should always check their cardmember agreement for details specific to their account.
A few more important facts to keep in mind:
- Separate interest rates and charges can apply to cardholder’s cash advance balance and balance transfer balances. Furthermore, many credit cards will impose a higher penalty interest rate when cardholders fail to make payments.
- Most credit card variable interest rates can change with the Prime Rate. The Prime Rate is an interest rate that is three percentage points above the federal funds rate, which is set by the Federal Reserve Bank. Because this interest rate can increase, cardholders should be careful not to incur more interest charges than they can comfortably pay each month.
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Remembering these simple facts about credit card interest will empower you to make the best financial decisions for yourself and your family.