When you use a credit card, you’re essentially borrowing money from the account’s credit limit. Just like any other loan, interest will be charged on the balance. How and when this interest is charged can have a huge impact on what you’ll pay to borrow money using your credit card.
In this guide, you’ll find answers to the most common questions about credit card interest, including the different rates that may apply and how to take advantage of interest-free days so you can avoid interest charges altogether.
What are credit card interest rates and how do they work?
Interest rates are a type of fee that’s charged when you borrow money. With credit cards, interest rates are calculated as a percentage of your balance and shown as an annual percentage rate (APR).
- For example, a card could have a purchase interest rate of 8.99% APR, while a different card could have a purchase interest rate of 19.99% APR.
Most credit cards also have different interest rates for different types of transactions, with the most common being:
- A purchase rate
- A cash advance rate
How is credit card interest calculated?
The interest rate on credit cards is normally shown as an annual figure, but most credit card companies calculate interest on a daily basis and then add the charges to your account at the end of each statement period.
To determine your credit card interest amount, your daily outstanding balance is multiplied by the daily interest rate on your credit card. These daily calculations are then added together at the end of the statement period to get the total interest due.
- The daily interest rate is calculated by dividing the APR by 365 days.
- The monthly interest rate is calculated by dividing the APR by 12 months.
As an example, if you have a 19.99% APR and an outstanding balance of $300 on your card:
- Your daily interest rate will be 0.054%, which has you paying $0.16 in interest a day.
- Your monthly interest rate will be 1.665%, which has you paying $4.99 in interest per month.
Compound interest costs
The way credit card interest is charged is known as “compound interest” because it is calculated daily. This means that you could end up paying interest on your interest charges. The good news is that you can cut down on interest costs any time you make a repayment, because that will also affect the daily interest calculation.
Types of credit card interest rates
Here are the most common types of interest rates you’ll find on credit cards:
- Purchase interest rate. This is the interest you are charged when you use your credit card for making payments in retail outlets or online. You only incur this interest rate if you don’t pay off your full balance by the due date.
- Cash advance interest rate. This is the interest rate you are charged when you use your credit card for withdrawing cash from ATMs or cash equivalent transactions, like buying gift cards or gambling.
- Balance transfer interest rate. This is the interest rate you’re charged when transferring an existing credit card debt to a new card.
- Promotional interest rate. Many credit card providers offer new customers promotional interest rates for purchases and/or balance transfers. This promotional interest rate is only available for a limited time, with the standard interest rate applying after the specified time period. For example, a card may offer you 0% interest on balance transfers for the first 6 months. If you didn’t pay off the balance transfer during the first 6 months, the standard rate for balance transfers would apply to the debt.
Even the smallest difference in credit card interest rates can have a huge impact on costs. When you’re looking for a new card, make sure you compare both the standard and promotional interest rates to help you find one that suits your needs.
Compare credit card interest rates
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Comparing credit card interest rates
To show you how important it is to compare interest rates, let’s say you have a balance of $1,000 on a credit card with an interest rate of 20.99% APR. If you only made monthly payments of $50 on this debt, it would take you around 2 years to pay off your balance and would cost you about $212 in interest.
On a credit card with an interest rate of 15.99% APR, it would still take around 2 years to pay off your balance but would cost you $153 in interest. That’s a saving of $53 compared to the card with a higher rate, which is basically another monthly repayment. The bigger the difference in rates, the greater these potential savings would be.
What else do I need to know?
As well as interest rates, make sure you consider the following when you’re looking for a new credit card:
- Interest-free days. Many credit cards offer up to a certain number of interest-free days on purchases when you pay your account balance in full by the due date on your statement. You should be offered a minimum of 21 interest-free days up to a maximum of 55 days. This gives you a way to avoid paying interest charges for spending on your credit card.
- 0% interest rate offers. If you get a credit card with a promotional 0% interest rate, it may only apply for certain types of transactions. For example, you could get 0% interest on balance transfers for 6 months but still have to pay the standard variable interest rate for any new purchases made during that time.
- Annual fee. Many credit cards charge an annual fee, which could also add to your account balance. Remember to factor this cost in when comparing credit cards and when budgeting for interest costs and repayments.
- Other features. Many credit cards offer complimentary extras such as insurance or rewards, which could help offset the cost of the annual fee and interest charges. Weigh the value of the benefits against potential costs so you can decide if a card is worth it based on your spending habits and goals.
When applying for a credit card, it’s important that you read the fine print to understand all of the terms and conditions of your agreement. Understand how much you will be charged for each type of transaction you make in order to plan your repayments and responsibly use your credit card.Back to top
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