Calculating Credit Card Interest: How Does Credit Card Interest Work?

Jason SteeleUpdated January 5, 2022

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Every time you make a purchase with your credit card, you’re taking a loan from the card issuer. And just as with any loan, the card issuer won’t lend you money without charging interest. That interest rate is expressed as the annual percentage rate, or APR. Read on to learn how credit card interest works and how to calculate credit card interest, so you can better take advantage of the benefits your card has to offer without incurring debt.

What Is Credit Card Interest?

A credit card issuer, such as a bank or credit union, will charge interest on your account’s balance until it is paid off. However, nearly all card issuers will waive interest charges when you pay your entire statement balance before the due date. You may also avoid credit card interest charges when you have a card with a 0% APR promotional financing offer. Otherwise, your monthly credit card statement will include interest charges that are calculated based on your account’s average daily balance.

How Does Credit Card Interest Work?

One of the most important parts of understanding a credit card statement is learning how credit card interest works. Interest charges will only apply if you carry a balance from one billing cycle to the next. If you have a balance at the end of your billing cycle, which is usually approximately 30 days long, you will see interest charges applied to your monthly credit card statement. These charges are calculated by dividing your APR by 365 (the number of days in the year) to get the daily rate, and then multiplying that figure by your account's current balance. This is why it can be helpful to make payments throughout the month rather than just at the end of the billing cycle — reducing your account balance will subsequently also decrease the interest charged.

How Are Credit Card Interest Rates Determined?

There are several factors that determine your interest rate. For starters, there are dozens of different credit card products offered by the major credit card issuers alone. Among them are cards that are designed for applicants with credit profiles ranging from poor to excellent, with an individual’s credit score depending on the following factors:

Payment history
Amounts owed
Length of credit history
Credit mix
New credit

When you have excellent credit, you’ll qualify for credit cards with the lowest possible interest rate. These will typically include premium rewards cards as well as more simple credit cards that offer the lowest possible interest rates. Those with more credit problems will only be able to be approved for cards with higher rates. These will include so-called subprime credit cards that have higher rates and fees, as well as secured cards. A secured card is one that requires the payment of a refundable security deposit before the account can be opened. Furthermore, many credit cards now offer multiple rates, or a range of standard interest rates for purchases. The rate you receive will be determined by your creditworthiness at the time of application. For example, a card might be advertised as having a standard interest rate of 14.99% to 23.74%, based on your creditworthiness. Or, it could offer rates of 13.99%, 17.99% or 20.99%, depending on your creditworthiness. Beyond the standard interest rate for purchases, there are several other rates that can apply to your credit card, which we discuss in further detail in our credit card dictionary but can include:

Balance transfer interest rate: Most credit cards will have a rate for balance transfers, which is often the same rate applied to new purchases.
Cash advance interest rate: Most credit cards will impose a higher rate for cash advances, as these are seen as riskier types of loans.
Penalty interest rate: When the card holder makes late payments, most credit cards will switch to a much higher penalty interest rate that reflects the greater risk of default when someone is struggling to pay their bills.

The Formula to Calculate Credit Card Interest

You calculate credit card interest based on your account’s average daily balance. You can determine an account’s average daily balance by adding up the balances of the account for each day of the billing cycle, and then dividing it by the number of days in the billing cycle. You will then determine the credit card’s average daily rate by dividing the APR by 365. Here’s an example of how this would work in practice: Let's say you have a credit card that has an APR of 15.99%, and you're carrying an average daily balance of $800. You'd convert your annual rate to a daily rate by dividing the APR of 15.99% by the number of days in the year, 365. This results in a daily rate of around 0.00044%. You would then multiply this figure by your account's average daily balance, so 0.00044% x $800, which comes to about $0.35. You would then multiply this amount by the number of days in your billing cycle, so $0.35 x 30, to determine your total interest charges added to your account at the end of the month: $10.50. Note that your interest charged could be a bit different depending on how your credit card issuer compounds interest, which is when your accrued interest is added to your daily balance, meaning you’ll end up paying interest on the interest you’ve racked up. The difference in monthly versus daily compounding won’t be massive, but it will result in a slightly different figure.

Daily Credit Card Interest Rate

Interest rates are presented as APR, which represents the interest and fees you pay over the year to borrow money (more on what APR is here). But to apply the APR to the balance on a daily basis, the APR is divided by 365, the number of days in a year. For example, if your credit card has an APR of 18.99%, then the daily percentage rate is 0.00052%. All of the interest charges for each day of the billing cycle are tallied up, and the resulting figure is then included on the credit card’s monthly statement and added to the account’s balance.

Average Daily Balance

Not only is this daily percentage rate applied to each day’s balance, but most credit card issuers will compound the interest daily. This means that on the first day of your billing cycle, the interest rate will be applied to just your average daily balance. But on the second day, the daily percentage rate will be applied to your average daily balance, including the interest charged on the first day. And on the third day of your billing cycle, the daily percentage rate will be applied to the second day’s balance, plus the second day’s interest charges. So, for example, if your average daily balance is $1,500, you’d incur interest on just that amount on the first day, which would total $0.78 if the daily percentage rate were 0.00052%. On the second day, you’d then pay interest on $1,500.78 (the average daily balance plus the first day’s interest charges) rather than the flat $1,500.

Total Interest

The pattern of compounding outlined above will repeat until the end of the month, and the total interest charges for each day will be added up. While these calculations might be difficult for most people to perform, the card issuer’s computers can do so instantly.

Tools to Help You Calculate Interest on a Credit Card

There are many tools online that can help you to calculate interest on credit cards. For example, ConsumerCredit.com offers a credit card interest calculator. Discover also offers a credit card interest calculator that will calculate your monthly payment, as do some other card issuers.

How to Calculate Credit Card Interest in Excel

You also can calculate your approximate interest charges in Excel quite easily. All you need to do is enter your account’s average daily balance and your account’s APR. Then, create a formula to calculate credit card interest that divides the account’s APR by 12 and multiplies it by the average daily balance. Note that this formula won’t take into account the effects of daily compounding as this would require a more complex formula. However, those effects will be very small over short periods of time when applied to the typical interest rates of credit cards. For most accounts, the additional effects of daily compounding interest will only amount to as little as a fraction of a cent each month, or just a few extra cents at worst.

How to Lower Your Interest Payments

Thankfully, there are several ways that you can lower your credit card interest payments. You can simply avoid all interest charges by paying your card’s entire statement balance each month. But if you already have a balance, and you’re trying to save money on interest while you pay it off, then there are several other options:

Pay more than the minimum each month: Always make sure to pay more than the minimum balance each month. When you pay just the minimum payment amount, then you’ll end up paying much more in interest charges while you pay off your balance. Also, the sooner you make a payment, the more it will reduce your account’s average daily balance. In fact, there’s no reason why you can’t make payments to your account multiple times a month, as soon as you have money available.
Transfer your balance to a card with a lower APR: Another strategy is to transfer your balance to a low interest rate credit card. There are balance transfer cards that offer 0% APR promotional financing for a period of at least six months, and often much longer. Alternatively, you can save money on interest by transferring your balance to a card with a lower interest rate.
Ask your credit card issuer for a lower rate: Finally, you can ask your card issuer to lower your card’s interest rate. If your creditworthiness has improved significantly since you opened your account, then you might qualify for a lower rate.

Compare Credit Card Interest Rates With Lantern

If you use a credit card, then it’s important to understand how credit card interest charges work and the best ways to reduce the amount of interest you pay. Armed with this knowledge, it will be much easier for you to evaluate and choose from the many credit cards available. Lantern can make this process even easier with its comparisons of various credit building cards and other types of credit cards that can help you find the right card for you.

Photo credit: iStock/cesar fernandez dominguez

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About the Author

Jason Steele

Jason Steele has been writing about credit cards and award travel since 2008. One of the nation's leading experts in this field, he has contributed to dozens of personal finance and travel outlets and has been widely quoted in the mainstream media.

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