Swipe smarter: your guide to credit card interest rates

A credit card can be a lifesaver when you’re in a financial pinch. But the interest that comes with it? Not so much.

Your card’s interest rate determines how much it’ll cost you to pay for expenses on credit. It could be a lot—or nothing at all—depending on how you use your card.

So how does interest work on a credit card? Here’s everything you need to know about why credit cards charge interest, how banks set their rates, and how to avoid paying interest in the first place.

How does credit card interest work? 

Credit card interest is a fee that you’re charged when you carry a balance on your credit card from one billing cycle to the next.

“Credit cards are loan products,” explains Karl Kaluza, vice president of marketing and communications at Member Access Processing (MAP), the nation’s largest aggregator of Visa card services for credit unions. “When a consumer uses a credit card to make a purchase, they are taking out a loan from the bank or credit union that has issued the card they are using.”

Credit card rates are variable, meaning they can fluctuate up and down according to changing market conditions. Rates are often based on the prime rate (the interest rate that financial institutions charge their best customers), plus a margin. 

Understanding interest rate vs. annual percentage rate (APR)

“Interest rate” and “APR” are often used interchangeably when referring to the cost you incur when carrying a balance on a credit card. Although these two terms technically refer to slightly different concepts, they’ are essentially the same thing when it comes to your card.

In general, an interest rate represents the cost of borrowing. In the context of a credit card, the interest rate is the cost of carrying a balance. It’s expressed as a percentage of the principal balance and doesn’t include any fees or other charges.

In most cases, an annual percentage rate is a more comprehensive measure of the cost of borrowing money over the course of a year. It includes the interest rate, plus any additional fees. For example, if you take out a mortgage, you usually pay closing costs and other fees upfront, increasing the total cost of the loan. So the APR represents the real cost of borrowing once these additional expenses are factored in. 

Credit cards can also come with annual fees, balance transfer fees, late fees, etc. However, there’s no way to predict exactly when a cardholder will incur these costs, so card companies only include interest in the APR. That’s why the interest rate and APR are basically the same thing when it comes to credit cards.

Types of credit card APRs

You might not realize that there is more than one APR that can be associated with your credit card. Different types of APRs may be applied in different situations. Here are the common types of credit card APRs you might encounter:

• Purchase APR: This is the interest rate that’s applied to the purchases you make with your credit card. If you don’t pay off the full balance by the due date, you’re charged the purchase APR on the unpaid balance.
• Introductory APR: Some credit cards offer a lower APR for a limited period as an incentive to attract new customers. The length of the introductory period is up to the card issuer, but in general, it tends to last from 12 to 21 months. After the promotional period ends, the APR reverts to the standard purchase rate.
• Balance transfer APR: This is the interest rate applied to any balance transferred from one credit card to another. Often, credit card companies will offer a low introductory balance transfer APR to incentivize people to transfer balances. However, balance transfers also usually come with a fee of around 3% to 5% of the amount transferred.
• Cash advance APR: This is the interest rate you’re charged when you use your credit card to get cash from an ATM or bank. “The interest rate charged on cash advances is usually much higher than purchase APRs and usually interest begins adding up immediately without a 30-day grace period,” Kaluza notes. Cash advances also often come with a fee, which can be expressed as a flat rate or percentage. 
• Penalty APR: This is a higher interest rate that is applied if you violate the terms of your credit card agreement, such as making late payments or going over your credit limit. But this higher APR shouldn’t come as a surprise. “Credit card issuers must disclose the conditions under which penalty APRs may be charged,” Kaluza says.

What is considered a good credit card interest rate?

What’s considered a “good” credit card interest rate really depends, especially considering that rates are variable. 

“A good credit card APR is anything at or below the national average,” says Ericka Wright, assistant vice president and branch manager at Addition Financial Credit Union. Currently, we’re experiencing a rising interest rate environment, and the average credit card rate now hovers just above 21%. So any rate below that would be considered pretty good, even though rates in this range would have been considered terrible 10 years ago.

Additionally, your own personal credit and financial profile has an impact on the interest rates you qualify for. “If you have a less-than-excellent credit score, you’re likely to receive a higher APR,” Wright says. 

A credit card applicant with a very good FICO score (i.e., 740 and up) is considered an ideal borrower because they’ve demonstrated a history of borrowing money responsibly. Therefore, they’re going to be offered the lowest rates available. On the other hand, a person with a score under 670 is considered a “subprime” borrower, and presents a higher risk of not paying their bills on time or defaulting on the account. So to compensate for that higher risk, credit card companies may charge them a higher interest rate. (If you have poor credit, you may want to consider a secured card instead.)

The good thing about credit cards is that unlike other types of financing, it’s up to you whether you pay any interest at all. Remember, you only accrue interest if you carry a balance month over month. “The best rate is 0% interest, because the cardholder has paid off their full balance within 30 days,” Kaluza says.

How to calculate credit card interest

Depending on the card, your interest may be calculated monthly or daily.

To calculate your monthly APR, divide your current APR by 12 (the number of months in a year). This gives you your monthly periodic rate. Then multiply that number by the amount of your current balance to get your monthly APR. 

For example, say you have a credit card with a $1,000 balance and 18% APR. To get your monthly APR, you divide 18% by 12, which is 1.5%. Then you multiply your balance of $1,000 by 0.015. The result is $15, which is what you should expect your interest charges for the month to be.

Alternatively, to find your daily APR, start by dividing your APR by 365 (the number of days in a year. This gives you your daily periodic rate. Then multiply your current balance by that number.  

Let’s use our previous example of a $1,000 credit card balance and 18% APR. First, divide 18% by 365 to get your daily APR. The result is about 0.0493%. Then multiply your balance of $1,000 by 0.000493. In this case, your daily periodic rate is $0.49. 

Finally, to calculate your estimated monthly interest charges, multiply this daily periodic rate by the number of days in your billing cycle. Most credit cards have a billing cycle of 30 days, which would equate to $14.70 in interest for the month.

Tips for minimizing credit card interest charges

Credit cards come with pretty hefty interest rates these days. So it’s important to avoid racking up interest when possible.

• Pay the balance in full: The best way to avoid paying interest is by paying off your full balance by the due date each billing cycle. If you don’t carry a balance, you don’t accrue any interest.
• Shop around for the best APR: Just to be safe, if you are looking to open a new credit card, it’s a good idea to get quotes for several cards and choose the one with the lowest rate. That way if you do have to carry a balance, you can keep interest costs down.
• Consider a balance transfer: If you already have some credit card debt that you’d like to pay down, consider transferring the balance to a card with an introductory 0% APR offer. You can use the time during the introductory period to pay down the balance faster, since you won’t accrue additional interest and 100% of payments will go toward the principal.

The takeaway 

When used right, Kaluza says credit cards essentially work as a free, 30-day loan. They can be a valuable financial tool, especially if you also earn rewards on your spending. 

However, if you carry a balance month over month, credit cards can become an expensive form of borrowing since the interest rates are usually higher than personal loans, home equity loans, and other forms of financing.

So if you choose to put expenses on a credit card, be sure to only charge what you can afford to pay back when the due date rolls around. And if you end up with a bigger balance, focus on eliminating that debt ahead of other, lower-interest loans to save money.

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