You vaguely remember seeing the interest rate when you signed up for your first credit card, but you didn’t give it too much thought. Now, you’re struggling to make your payments on time. Each month, you see an interest charge on your credit card statement, and it seems to keep rising. “How does credit card interest work?” you wonder. Is there a way to lower your monthly credit card interest even though you can’t pay your balance in full?
Perhaps it’s been a while since you opened your credit card bill. You make most of your payments online or via a mobile device, so you don’t get a paper statement. Because of this, you might not know what your interest rate actually is. Luckily, it’s easy to find your credit card’s interest rate, also called an annual percentage rate (APR), as well as how much you’re actually charged in interest each billing cycle.
The APR is the annual cost of borrowing on your credit card. Because credit cards are a form of revolving credit, meaning your balance can go up and down within the year, an APR provides a way to consistently measure your borrowing costs. APRs also allow you to comparison shop between credit cards and banks to see the interest they charge.
If you receive paper credit card statements, the amount you’re charged in interest each month will likely be listed toward the end of your bill where it says, “Interest charged.” On a mobile device or computer, you’ll likely have to go to the section called “Statements” and download a PDF of your bill to get this information.
However, this is just the amount you’re charged in interest. To figure out the actual interest rate, you’ll have to dig a little deeper. On most credit card statements, there will be a section titled, “Interest Charge Calculation” or something with similar wording. Here, you will be able to access your APR.
For the purposes of figuring out your credit card interest, you’ll likely just want to look at the purchase APR. However, there might be different types of APR listed, such as a “balance transfer APR” or a “cash advance APR.” Note these different APRs too, especially if you took advantage of a balance transfer promotion from your credit card, and to know the high cost of using your credit card at the ATM. Also note any penalties for missing the minimum payment each month since your APR, often called a “penalty APR,” could go up.
Next to your APR, there might be a “(v).” For example, your credit card statement might say, “18.5%(v).” This means the interest rate is 18.5% and it’s variable. (Most credit cards have variable interest rates, not fixed interest rates. Other forms of credit, such as mortgages, typically have fixed interest rates.)
Because the interest rate is variable, the actual APR can be higher or lower each month depending on the bank’s cost of money, typically the “prime rate” which is influenced by the policies of the U.S. Federal Reserve. The bank adds its charge on top of the prime rate, so your APR moves up or down with the bank’s costs.
There’s more to credit card interest than it seems. You aren’t simply charged 18.5%, or whatever your APR is, of your ending balance once a year. Instead, interest is charged on a daily basis in the form of what’s called a daily rate. (Remember: The interest rate is only charged if you carry a balance each month.)
Here’s how you can figure out your credit card interest:
1. Find your daily rate. The first thing you’ll want to do is convert your annual rate to a daily rate. This can be done by taking your APR and dividing it by 365. For example, if your APR is 18.5%, you’d divide 18.5% by 365 and get a result of 0.0506%. That’s your daily interest rate, also referred to as a daily periodic rate.
2. Identify your average daily balance. Once you’ve identified your daily rate, you’ll want to figure out your average daily balance. Take a look at the most recent billing period of your credit card statement. Add up the daily balances for each day, and then divide that number by 30 or 31, depending on the number of days in that month. (Or 28, if it’s February!)
3. Do some math. To calculate how much you paid in credit card interest, you’ll want to multiply your daily rate by your average daily balance. Once you have that number, you’ll want to multiply it by however many days were in the billing period. For example, let’s say your average daily balance for the month of August was $500. You’d multiply $500 by 0.0506%, then multiply that result by 30. You get $7.59. This is how much interest you paid during this billing cycle.
A Note About Compound Interest
You might look at your credit card statement and wonder why the daily balance changed despite no charges or payments being made. This is because credit card interest is compounded. For example, in the above scenario, if you had not paid your balance off during the previous billing cycle, you begin the new billing cycle with a balance owed, in this case $500. The amount of interest you’d pay each day is roughly 25 cents. This 25 cents will be added to your unpaid balance each day. So on day 1, your balance would be $500, and the daily rate of 0.0506% would be charged on that. On day 2, your balance would be $500.25, and the 0.0506% daily rate would be charged on that, and so on and so forth.
How Can I Lower My Credit Card Interest?
Just as the power of compounding works in your favor when you save money with interest, compound interest goes against you when it comes to debt. Each purchase charged on your credit card, if it’s not paid off, actually costs you more than what you paid at the cashier. As the balance on your credit card grows, so do the interest charges, and those interest charges gain more interest. This is why keeping balances on your credit cards is like watering weeds — the interest “weeds” bear more “weeds,” and that’s why your consumer debt just keeps growing and growing.
The best way to lower your credit card interest is, of course, by paying your balance on time and in full each month. If you do this, you’ll be able to avoid paying any interest whatsoever. With an average credit card interest rate of over 16% on new credit cards in the U.S., it’s wise to avoid paying interest if you can.
If you can’t pay your credit card balance in full, you’re not alone: The average American household has an outstanding credit card balance of nearly $7,000.
Luckily, there are a handful of ways you can lower your credit card interest charges even if you can’t pay your balance in full each month. Here are a few solutions.
Pay Off Your High Interest Credit Cards
If you have several credit cards and built up a balance on a particularly high APR credit card, prioritize paying that one off. Make as large a payment as you can on that one card, even if you can only make minimum payments on the others. Avoid adding to the balance by paying in cash or using another card. Once the highest APR card is paid off, put the card away! Don’t close the account — leaving it open helps you maintain your credit history — but resist using it again after all that work to pay it off. Then move on to pay off the card with the next highest APR, and so on.
Make Payments Throughout the Course of Your Billing Cycle, Even If They’re Small
You might think, “What’s the point of making a $50 payment? It’s not lowering my balance significantly. It doesn’t matter.” But if you’re looking to save on credit card interest, every payment — even small ones — can make a difference.
In the above calculation, you figured out your average daily balance by taking each day’s balance, adding them together, and dividing that number by 30 or 31.
Let’s say your balance was $500 at the beginning of the billing cycle. If you’re able to make just a few small payments during the course of the billing cycle — say $50 here and $75 there — you’ll be able to lower your average daily balance and, in turn, your credit card interest paid.
Here’s an example of how this would work: Let’s say you made a $50 payment on the 10th day of your billing cycle, bringing your balance to $450, and then a $75 payment on the 20th day, bringing your balance to $375. Using the above daily rate, you’d pay $7.59 in interest by making no payments throughout the month. But by making the $50 and $75 payments on those days, you’d only pay $6.70 in interest for the month.
Fortunately, online or automatic payments help make these in-between cycle payments easy to schedule. You’d also see your credit balance go down, and that can be motivating to pay off the debt even faster.
Make a Large Payment Early on in Your Billing Cycle
If you’re able to make one large payment toward the beginning of your billing cycle, you’ll bring down your average daily balance and, in turn, your overall credit card interest.
Here’s an example of how this would work: Let’s say you make a $150 payment on the fifth day of your 30-day billing cycle. In the above example in which your average daily balance is $500 and you make no payments, your total interest paid is $7.59. But if you make that $150 payment on the fifth day of the billing cycle, your total interest paid for the month will only be $5.69 because you lowered your average daily balance early on in the month.
If you made that $150 payment on the 25th day of the month, however, you’d paying $7.21 in credit card interest because you didn’t lower your average daily balance early enough. Therefore, if you’re going to make a $150 payment no matter what, it’s better to make it toward the beginning of your billing cycle.
Negotiate a Lower APR
That’s right — you can negotiate to get a lower APR than what you had signed up for when you started. The competition for credit card customers is fierce, and banks and credit card companies spend thousands of dollars in marketing and promotions to win you as a customer. Shop around for credit cards with similar features (like airline miles and loyalty points) but have lower APRs than yours, and call your credit card company to see if they’ll match the lower rate.
If you’ve been a long-time customer of theirs and have good credit history, they just might say yes. Companies know it could cost them so much more in the end if they lose you as a customer. Bonus: You get a bit of negotiation experience and realize your power as a consumer.
Check Your Credit Card’s Grace Period
Some credit card companies will offer a grace period. This means there is a cushion of time between when your billing cycle ends and your actual payment due date. This grace period is typically around 21 days. If you can make your credit card payment in full during this grace period, you won’t be charged any interest.
Not all credit cards come with grace periods, so check your credit card issuer’s cardholder agreement to see if yours does.
How Does Credit Card Interest Work? Now You Know
If you’re looking to save money on credit card interest, the most important thing you can do is pay your balance in full and on time each month — or at least within the credit card’s grace period. If you cannot pay your balance in full, consider one of the above strategies to minimize the interest charges and their compounding effect.
Looking to learn more about the best way to manage debt? Consider learning about debt consolidation and how mortgages work. You’ll soon be capably managing your debt to your advantage, rather than letting debt manage you.