How Does Credit Card Interest Work? | Santander Bank - Santander
How Does Credit Card Interest Work?
You might be familiar with terms like Annual Percentage Rate (APR) and interest as they relate to credit cards, but what do those terms mean for your financial health? Understanding how credit card interest works, and how to calculate your credit card interest, can help you build or maintain a strong financial profile and stay out of debt. Credit card APR works a little differently from other types of APR, like mortgages or car loans.
What is credit card interest?
Credit card interest is the amount you'll pay, on top of what you spent purchasing items and services, if you leave an unpaid balance on your credit card between statement periods. To avoid paying interest on a credit card, make sure you pay the full statement balance by the statement due date. Some transactions begin accruing interest immediately, such as cash advances or balance transfers. Regularly carrying a balance on your credit card statement can quickly lead to credit card debt.
Interest rates explained
Your APR is how your credit card interest rate is expressed, similar to the way horsepower expresses the strength of an engine. To understand how your overall APR will impact your monthly statement balance, you’ll have to do some math. Despite its title, APR is calculated daily and applied monthly.
Types of credit card interest
There are two main types of interest: fixed and variable. Fixed interest rates stay relatively consistent. A fixed rate may change, but your card issuer will usually notify you beforehand. Variable interest rates will fluctuate over time as benchmarks set by reputable financial establishments (like the Federal Reserve Prime Rate) change.
Your credit card issuer may charge you different interest rates based on the type of transaction. These may include:
- Purchase APR: Charged on credit card purchases you make when those purchases appear on the statement and the statement balance is not paid in full. This is the most common type of APR and applies to almost every credit card.
- Balance Transfer APR: Charged to balances transferred from other accounts when a balance is carried. This rate may not be the same as the card's purchase APR, so be sure to read your cardholder agreement carefully. Unless the Balance Transfer rate in your account is at a promotional 0% APR, you will pay interest from the day the transaction was completed.
- Cash Advance APR: Charged when you use your credit card to get cash. This rate is usually much higher, which can make it expensive to borrow money this way. Like balance transfers, cash advance interest is charged from the day the transaction was completed.
- Penalty APR: Some cards may charge a penalty rate if the cardholder doesn’t make a minimum payment on time. These rates are typically pretty high.
- Promotional APR: You may see a credit card company offer a promotional rate for a limited time (number of months) when you open a new card. For example, 0% introductory APR on purchases or balance transfers for the first year. These offers can help customers make large purchases without paying a lot in interest, or transfer existing balances as a break from high interest at another financial institution. Standard APRs typically kick in immediately after a promotional period ends, so make sure you’re aware of that date and how you’ll be charged interest. Try to pay down your balances beforehand.
How does credit card interest work?
If you carry a balance on your credit card, the card company will multiply it each day by a daily interest rate and add that to what you owe. The daily rate is your annual interest rate (the APR) divided by 365.
For example, if your credit card APR is 16%, the daily rate is 0.044%. With an outstanding balance of $500 on day one, and assuming you do not make any new purchases, you would incur $0.22 in interest every day until the end of the month. So if your statement is generated within 30 days after day one, you would be charged $6.60 in interest. So, a balance of $500 at the beginning of the month, adding no other charges, brings you a balance of $506.60, including interest, at the end of the month. Note that making purchases throughout the month would increase both your balance and interest.
How to calculate credit card interest
To calculate how much interest you’ll be charged on a given day, you'll need your average daily balance, the number of days in your billing cycle, and your APR.
- Divide your APR by 365. A rate of 16.27% (0.1627) / 365 days = 0.00044 daily rate
- Multiply the daily rate by your daily average balance. 0.000444 x $2,000 = $0.89
- Multiply that amount by the number of days in your billing cycle. $0.89 x 30 days = $26.74
How to avoid interest on a credit card
The only way to completely avoid being charged interest is to pay your balance in full each billing cycle, and avoid any transactions that begin accruing interest immediately (such as a cash advance). If you do carry a balance, paying it down as quickly as possible will help you reduce interest charges. When you have some cash to spare, it may be a good idea to pay down your credit card balance.
If you're paying high interest, you could transfer your balance to a credit card with a promotional rate for balance transfers and effectively pause your interest charges. This would allow you to pay your balance down faster in the 6–18-month promotional window.
Get help with credit card interest
Simply understanding how credit card interest works is an important part of managing your financial wellness. When you know the factors that affect your credit card's interest charges, you can make good decisions to help minimize or avoid charges altogether.
Santander can help you understand how credit card interest works, how you can minimize your charges, or with any other credit card-related questions you might have.