How does credit card interest work? | finder.com
How does credit card interest work?

How does credit card interest work?

We value our editorial independence, basing our comparison results, content and reviews on objective analysis without bias. But we may receive compensation when you click links on our site. Learn more about how we make money from our partners.

Credit card interest can be confusing, but let’s clear the air. Here’s the lowdown on interest so you can apply for credit cards with confidence.

People make a big deal out of interest rates when applying for credit cards. They tell you interest is important, and that you should carefully compare rates between credit cards.

They’re right, of course. But why are interest rates so important? More fundamentally, what is interest?

In this guide, we demystify how credit card interest works.

Find your ideal rewards credit card

See our recommendation in two clicks.


Back to top

What is interest?

Why is interest such an important feature of credit cards?

To answer this, let’s talk about the function of a credit card. When you make a purchase on your card, you’re borrowing money from your credit card company. Instead of carrying around $500 in cash to buy a new TV, you swipe your card and pay your card company back later.
After you make the purchase, you have two options:

  • Pay back the money you owe immediately.
  • Pay back just a little of the money and continue to carry a balance on your credit card.

Did you know

Your balance is the amount of money you owe on your card.

If you choose to carry a balance on your card (meaning you’re continuing to borrow money), your card provider isn’t going to let you do it for free. For the privilege of borrowing money, you pay your provider interest.

Interest is money you pay to your lender as a fee for borrowing money.

Back to top

How interest is charged

Card companies express interest in the form of an APR or annual percentage rate. For example, your APR could be 15%, which is a standard interest rate across the industry.

This doesn’t mean that your card provider charges you interest once a year. Instead, it applies your APR to your balance either every day or every billing cycle.

There are different methods of calculating interest. The biggest card companies generally use two methods: daily balance and average daily balance.

Let’s go over how these methods work.

Back to top

The daily balance method

In your card’s terms and conditions, you may see this method written as “daily balance (including new transactions).”

Because interest is calculated every day, your card company begins by finding your daily periodic rate. This is just your APR divided by 365, the number of days in a year.

Every day, your card company multiplies the daily periodic rate by your balance. That gives them your daily interest.

PRO TIP

Card companies don’t always use 365 days to calculate your daily periodic interest rate. They sometimes use 360 days.

The card company adds that daily interest to your balance, resulting in your new current balance. Then the process starts over again the next day.

That’s the gist of it, but take a look at the math in the example below.

An example of the daily balance method

If your APR is 20%, your daily periodic rate will be 20% divided by 365 days — or .054795%. (That’s 0.00054795 on a calculator.)

Let’s say you’re carrying a $5,000 balance on your credit card.

Day Interest
Using interest calculations on Day 1:
  • You’ll be charged $5,000 x 0.00054795 — or $2.74 in interest.
  • That brings you to a new balance of $5,000 + $2.74 — or $5,002.74.
On Day 2:
  • You’ll be charged $5,002.74 x 0.00054795 — or $2.74 in interest.
  • That brings you to a new balance of $5,002.74 + $2.74 — or $5,005.48.

Now, let’s say you make a $200 purchase on Day 3.

With a $200 purchase, on Day 3:
  • Your new balance is $5,005.48 + $200 — or $5,205.48.
  • You’ll be charged $5,205.48 x 0.00054795 — or $2.85 in interest.
  • That brings you to a new balance of $5,205.48 + $2.85 — a total of $5,208.33.

Finally, let’s say you pay off $400 of your balance on Day 4.

With a payment of $400, on Day 4:
  • Your new balance is $5,208.33 – $400 — or $4,808.33.
  • You’ll be charged $4,808.33 x 0.00054795 — or $2.63 in interest.
  • That brings you to a new balance of $4,808.33 + $2.63 — or $4,810.97.

If you do nothing else on your credit card for the rest of the month (and we keep repeating the interest calculation), you’ll accrue $79.98 in interest for this billing cycle.

The process is tedious, but that’s how daily interest works.

How does this look over a calendar month?

DAILY BALANCE METHOD Money Transfers

Back to top

The average daily balance method

In your card terms, you may see this method written as “average daily balance (including new transactions).”

Like in our previous method, you start with finding your daily periodic rate.

Next, you find the average of all of your daily balances over the billing period. You do this by adding your balances for every day in the period divided by the number of days in the billing cycle.

Finally, you multiply your daily periodic rate by your average daily balance. Then you multiply the result by the number of days in the billing cycle. This gives you the interest you’ll pay for this billing cycle.

To clarify how this works, let’s go over an example.

An example of the average daily balance method

Like in our other example, let’s say you’re paying 20% APR on a $5,000 balance. Again, the daily periodic rate will be 20% divided by 365 days — or .054795%. (That’s 0.00054795 on a calculator.)

On Days 1 and 2, you don’t do anything with your card, so your balance is unchanged.

Day Interest
On Day 1:
  • Your balance is $5,000.
On Day 2:
  • Your balance is $5,000.

On Day 3, you make a $200 purchase.

With a $200 purchase, on Day 3:
  • Your new balance is $5,000 + $200 — or $5,200.

And on Day 4, you make a $400 payment toward your balance.

With a $400 payment, on Day 4:
  • Your new balance is $5,200 – $400 — or $4,800.

Let’s say you don’t use your card again for the rest of the month. That means on Days 1 and 2, your balance was $5,000; on Day 3 your balance was $5,200; and the balance for Days 4 through 30 was $4,800.

First, we’ll add up the balances for the month:

$5,000 + $5,000 + $5,200 + ($4,800 x 27 days) = $144,800

Then we’ll divide that number by the number of days in the billing cycle:

$144,800 / 30 = $4,826.67
Our average daily balance is $4,826.67.

Now, we multiply our daily periodic rate, our average daily balance and the number of days in the billing cycle.

0.00054795 x 4,826.67 x 30 = $79.34
This means that in our next billing statement, we’ll see a $79.34 charge for interest.

How does this look over a calendar month?

DAILY AVERAGE BALANCE Money Transfers

Back to top

But do you have to pay interest?

credit card interestOne misconception about interest is that you have to start paying it immediately. In fact, most credit card companies give you a grace period during which you can pay off your debt before interest kicks in.

Your card company should list the length of this grace period in its terms and conditions. Terms typically look something like:

Your due date will be a minimum of 21 days after the close of each billing cycle. We will not charge you interest on purchases if you pay your entire balance by the due date each month.

Here are a few examples of how that process works.

Example 1: You pay off your balance in full each month

Let’s say you’ve made $100 in purchases in the first month you open your card (we’ll say it’s January).

  • After the end of January (when your billing cycle ends), you’ll receive your credit card statement. You need to pay back that $100 you charged to your card.
  • Now you have a 21-day period to pay that $100. You pay off the $100 on February 15.

Since you owed $100 but then paid off $100, your balance is $0. In terms of interest, you’re free and clear for now.

There are benefits to this situation:

See the pattern? If you completely pay off your balance each month by the due date, you’ll never owe interest.

Example 2: You don’t pay off your balance in full each month

Again, let’s pretend you make $100 in purchases in the first month you open your card (January).

  • After the close of the billing cycle, you get a credit card statement for $100. On February 15, you pay only $50 toward your balance.

You owed $100 but paid off $50, so you’re still carrying a balance. There are disadvantages to this situation:

As you can see, this is one of the ways you can get into snowballing credit card debt. Carrying a balance can be dangerous.

Back to top

The bottom line

We’ve made a lot of calculations in this guide to demonstrate how interest works. However, interest doesn’t really have to be that complicated. Your goal is to keep it as low as possible by paying off your balances as quickly as possible.

Name Product Credit Score Min. Annual Fee Intro Balance Transfer APR Reward Value per Dollar Secured or Unsecured Annual Fee APR for Purchases (Purchase Rate) Intro APR for Balance Transfer
680
95
0%
1
Unsecured
$95
14.99% to 25.99% variable
0% for the first 12 months (then 14.99% to 25.99% variable)
Earn $200 bonus cash back after you spend $1,000 on purchases in the first 3 months. Rates & Fees
680
0%
1
Unsecured
$0
14.99% to 25.99% variable
0% for the first 15 months (then 14.99% to 25.99% variable)
Earn a $150 bonus statement credit after you spend $1,000 on purchases in the first 3 months. Rates & Fees
680
550
1
Unsecured
$550
None (Charge Card)
Get 5X Membership Rewards® points on flights booked directly with airlines or with American Express Travel and 5X points on eligible hotels booked on amextravel.com. Rates & Fees
680
0%
1.5
Unsecured
$0
14.99% to 25.99% variable
0% for the first 15 months (then 14.99% to 25.99% variable)
Earn up to $250 back. Earn $150 back after you spend $1,000 or more in purchases with your new Card within the first 3 months of Card Membership. Plus, earn an additional $100 back after you spend an additional $6,500 in purchases within your first 12 months. You will receive the cash back in the form of a statement credit. Rates & Fees
720
0%
Unsecured
$0
13.99% variable
0% for the first 15 months (then to variable)
A low, variable APR on purchases, balance transfers and cash advances.
680
1
Unsecured
$0
17.74% to 26.74% variable
Earn 10,000 Bonus Miles after spending $500 in purchases on your new Card in your first 3 months of Card Membership. Rates & Fees
680
95
1
Unsecured
$0 annual fee for the first year ($95 thereafter)
17.74% to 26.74% variable
30,000 bonus miles after you use your new card to make $1,000 on purchases within the first 3 months. Rates & Fees
680
95
2
Unsecured
$0 annual fee for the first year ($95 thereafter)
17.74% to 26.74% variable
Enjoy a $0 annual fee on the first year and earn up to 2 Starpoints® for every dollar of eligible purchases. Rates & Fees
680
95
3
Unsecured
$95
17.74% to 26.74% variable
Earn 125,000 Hilton Honors™ Bonus Points after you spend $2,000 or more in purchases with your new Card within the first 3 months of Card Membership. Rates & Fees
680
3
Unsecured
$0
17.74% to 26.74% variable
Earn 75,000 Hilton Honors™ Bonus Points after you spend $1,000 in purchases on the Card within your first 3 months of Card Membership. Rates & Fees
715
495
0%
1
Unsecured
$495
16.99% variable
0% for the first 15 billing cycles (then to variable)
Mastercard Black Card members receive an annual $100 air travel credit toward flight-related purchases including airline tickets, baggage fees, upgrades and more.
195
0%
1
Unsecured
$195
16.99% variable
0% for the first 15 billing cycles (then to variable)
Enjoy unique excursions, privileged access to exclusive events and insider opportunities.
715
995
0%
2
Unsecured
$995
16.99% variable
0% for the first 15 billing cycles (then 16.99% variable)
Earn points every time you spend. Luxury Card enhances your purchasing power by providing you with one (1) point for every one dollar ($1) you spend. Every purchase gets you closer to the rewards you want.
620
39
Unsecured
$39
24.99% variable
Designed to help build credit history with no deposit required and access to benefits.
620
99
Unsecured
$75 annual fee for the first year ($99 thereafter)
23.9% variable
With this card you get a 23.9% Variable APR.
300
48
0%
Unsecured
$75 annual fee for the first year ($48 thereafter)
29.99% variable
The First Access Card is a true VISA® credit card that does not require perfect credit for approval.
300
Unsecured
Up to
19.74% to 25.74% variable
Get 1% cash back rewards on eligible purchases including gas, groceries, and services such as mobile phone, internet, cable and satellite TV, terms apply.
720
0%
1
Unsecured
$0
15.24% to 25.24% variable
0% for the first 12 statement closing dates (then 15.24% to 25.24% variable)
Earn more cash back for the things you buy most.
720
95
1
Unsecured
$0 annual fee for the first year ($95 thereafter)
17.74% to 24.74% variable
Earn 50,000 bonus points after you spend $4,000 on purchases in the first 3 months from account opening. That's $625 toward travel when you redeem through Chase Ultimate Rewards®
720
450
1
Unsecured
$450
17.74% to 24.74% variable
Earn 50,000 BONUS POINTS after spending $4,000 on purchases in the first 3 months from account opening* — that's $750 toward travel when you redeem through Chase Ultimate Rewards®.
690
0%
1.5
Unsecured
$0
16.74% to 25.49% variable
0% for the first 15 months (then 16.74% to 25.49% variable)
Earn unlimited 1.5% cash back on every purchase - it's automatic. No minimum to redeem for cash back.
680
95
1.5
Unsecured
$95
17.74% to 24.74% variable
Earn unlimited 2 points for every $1 spent on travel and dining purchases and 1.5 points for every $1 spent on all other purchases.
690
0%
1.5
Unsecured
$0
14.74%, 20.74% or 24.74% variable
0% for the first 15 months (then 14.74%, 20.74% or 24.74% variable)
Earn unlimited 1.5% cash back on every purchase, every day
690
0%
1
Unsecured
$0
16.74% to 25.49% variable
0% for the first 15 months (then 16.74% to 25.49% variable)
Earn 5% Cash back in bonus categories up to $1,500 every quarter. Earn 1% Cash back on all other purchases.
680
1.5
Unsecured
$0
16.99% to 24.99% variable
for the first 12 months (then 16.99% to 24.99% variable)
An intro offer rewards cardholders with a $250 value (25,000 online bonus points) after spending $1,000 within the first 90 days of account opening
680
0%
Unsecured
$0
16.74% to 25.49% variable
0% for the first 15 months (then 16.74% to 25.49% variable)
Jumpstart your financial fitness! 60 day introductory balance transfer offer, save on interest, and get your free monthly credit score.
750
95
2
Unsecured
$0 annual fee for the first year ($95 thereafter)
14.74%, 21.24% or 24.74% variable

Compare up to 4 providers

Back to top

Have any questions?

We know that credit card interest can be confusing. Contact us with any questions.

Back to top

Frequently asked questions

Back to top
Was this content helpful to you? No  Yes

Ask an Expert

You are about to post a question on finder.com:

  • Do not enter personal information (eg. surname, phone number, bank details) as your question will be made public
  • finder.com is a financial comparison and information service, not a bank or product provider
  • We cannot provide you with personal advice or recommendations
  • Your answer might already be waiting – check previous questions below to see if yours has already been asked

Finder only provides general advice and factual information, so consider your own circumstances, or seek advice before you decide to act on our content. By submitting a question, you're accepting our Privacy and Cookies Policy and Terms of Use.

US Credit Card Offers

Important Information*
Deserve® Classic Card
Deserve® Classic Card

APR

24.49
variable

Annual fee

0 For the first year
More info
Luxury Card Mastercard® Gold Card™
Luxury Card Mastercard® Gold Card™

APR

16.74
variable

Annual fee

995 For the first year
More info
First Access Visa Card®
First Access Visa Card®

APR

29.99
variable

Annual fee

75 For the first year
More info
Indigo® Platinum Mastercard® Credit Card
Indigo® Platinum Mastercard® Credit Card

APR

23.9
variable

Annual fee

75 For the first year
More info
Go to site