What is credit card interest?
Credit card interestis the cost you pay for borrowing money from your credit card issuer. It is typically expressed as anannual percentage rate (APR).
Representative APR is the interest rate that the credit card provider must offer to at least 51% of accepted borrowers. It includes both the interest rate and any additional fees or charges associated with the credit card.
The particular rate you get depends on your financial situation.
How is credit card interest calculated?
Credit card companies calculate interest based on yourbilling cycle. If you don’t pay your balance in full by the end of the billing cycle, you’ll usually be charged interest on the remaining balance. Interest is charged on the average daily balance between bills.
The credit card company takes your annual interest rate and turns that into a daily rate. Most divide by 365 but some firms use 360. They then apply this to your average daily balance each month.
Do all credit cards calculate using compound interest?
Most credit cards compound your interest daily. This means that interest is added to the outstanding balance each day. The interest the next day is added on top.
Think of it like a rolling snowball gathering extra snow each roll. To start with the amount added is small but with each full turn the amount added on gets larger.
The impact of compound interest will steadily increase the amount of debt you owe over time. In a month it might only make a small difference, but over many months or years it mounts up.
Example calculations
Compound interest is added daily, snowballing rapidly. Here’s how interest would grow on £500 of debt with an APR of 25%:
Month | Interest | Accrued Interest | Balance |
1 | £10.52 | £10.52 | £510.52 |
2 | £10.74 | £21.27 | £521.27 |
3 | £10.97 | £32.24 | £532.24 |
4 | £11.20 | £43.44 | £543.44 |
5 | £11.44 | £54.87 | £554.87 |
6 | £11.68 | £66.55 | £566.55 |
7 | £11.92 | £78.47 | £578.47 |
8 | £12.17 | £90.65 | £590.65 |
9 | £12.43 | £103.08 | £603.08 |
10 | £12.69 | £115.77 | £615.77 |
11 | £12.96 | £128.73 | £628.73 |
12 | £13.23 | £141.96 | £641.96 |
Here’s how much you would owe if you had a balance of £500 using daily compound interest at different interest rates:
APR | 1 Month | 1 Year | 3 Years |
20% | £508.40 | £610.67 | £910.91 |
25% | £510.52 | £641.96 | £1,058.23 |
30% | £512.65 | £674.85 | £1,229.35 |
35% | £514.79 | £709.41 | £1,428.11 |
What is ‘risk based’ pricing
Risk-based pricing is the method used by banks to set the APR for different customers. It is based on factors such as income, debt and your credit score. Borrowers with higher credit scores typically get lower APRs.
A high credit score suggests you have borrowed in the past, not borrowed excessively, and paid off your debts promptly. This suggests you are a low risk to the lender.
If you have a low credit score you could be offered an APR much higher than someone with a good credit score.
A low credit score may be because you have not borrowed before, you have borrowed a lot of your available credit, or you have failed to pay your debts on time. This suggests to the lender you are high risk.
Your credit utilisation ratio is the amount you’ve borrowed divided by the amount of credit you can have. It’s a factor that affects your personal credit score. People with the best credit scores keep their credit utilisation ratio below 25%. Lenders think you are a lower risk if you use less of your available credit.
Is APR the same as credit card interest?
The credit card’s annual percentage rate (APR) isn’t exactly the same as its interest rate. The APR is the total amount you’ll pay per year for borrowing on your credit card, including any other fees from the lender. For example, these may include annual fees or balance transfer fees.
The interest rate is just the interest that’s applied to your outstanding balance – so it doesn’t include any other fees. The APR is usually the best way to compare the total cost of borrowing over the year.
When do you pay credit card interest?
Unless you are in an interest-free promotional period you’ll pay credit card interest if you fail to pay off your entire balance each month. The date you will pay it depend on when your bill arrives and when it falls due. You can ask your credit card company to change the date you pay your bill.
Different credit card providers have different rules for when they charge interest. Most card providers charge interest from your billing date until you pay off your balance. But some may charge interest from the date of each transaction.
How does interest affect your credit card payments?
Interest increases the amount you owe your credit card provider.
It will increase:
- Your monthly minimum payment
- The amount you need to pay to clear your balance
- The monthly amount needed to pay off your card over a fixed period, making your monthly minimum payment bigger.
Types of credit card interest and key terms
Purchase Interest | Purchase interest is the rate applied to new purchases and any balances carried over to your next bill. This is usually the APR you receive on the card. Your rate will usually depend on the credit card you get and your credit rating. If you pay your bill in full and on time every month, you usually avoid paying purchase interest. |
Cash Advance Interest | Cash advance interest is charged when you use the credit card to withdraw cash. A higher interest rate applies when you use the card to get cash. Cash advance APRs can be 25% or higher, so it’s important to beware of the higher rate. Plus, interest builds up from the date of the transaction. |
Balance Transfer Interest | Balance transfer interest is the interest you’ll pay when you move debt from one credit card to another. It only applies to the balance you move from one card to another. You’ll still have the same amount of debt, but on a different card. Some card providers offer 0% transfer deals on balance transfers that run for 12 to 28 months. |
Variable Rate | The interest rate can change periodically based on market conditions. |
Fixed Rate | The interest rate remains constant over time |
Introductory Rate | Some credit cards offer a lower interest rate for an initial period (e.g., 0% APR for the first 12 months). |
Promotional Rate (e.g. 0%) | Some cards offer a 0% interest rate for a number of months on balance transfers or new purchases. This can enable you to repay debt over a number of months without paying any interest. |
Grace Period | Most credit cards have agrace periodduring which no interest is charged if you pay your balance in full by the due date. If you carry a balance beyond the grace period, interest accrues. |
Minimum Payment | Even if you can’t pay the full balance, make at least theminimum paymentto avoid late fees and negative credit impact. However, paying only the minimum will result in higher interest charges. |
Remember that credit card interest can add up quickly, so it’s essential to manage your balances responsibly and pay off debts promptly.
Higher balances and APRs mean you’ll pay more interest. If you fail to pay more than the minimum balance or make any payments towards your debt, interest charges continue to build up. Compound interest increases the cost. This can make it more difficult to become debt-free.
You can use one of the many free credit card calculators to work out how quickly you can pay off your debt. These may also show how changing your repayments can clear your balance faster. For example, consumer association Which? and MoneyHelper have free calculators.
If you’re unsure about specific terms or rates, consult your credit card agreement or contact your issuer for clarification.
Steps to reduce or avoid paying credit card interest
Credit card interest can be expensive, but you can take steps to avoid or reduce the amount of interest you pay. Here are some of the best ways to use your credit card without paying interest charges:
Make full payments each month
The best way to never pay credit card interest is to pay off the full balance by the due date each month. The easiest way to do this is to set up a direct debit to repay your balance in full each month – if you can afford to do so.
Leverage interest-free periods
It’s worth making use of interest-free periods if you want to transfer a balance from another card or make a large purchase. These deals give you some time to pay off your credit card debt without paying interest. But you may still pay interest once the promotional interest-free period ends.
Consider balance transfer cards
You could move your existing credit card debt to a balance transfer card offering a 0% rate for 12-28 months. This enables you pay off your credit card balance without paying hefty interest charges – or any at all.
Avoid using the new card for purchases during the promotional period. Bear in mind that you’ll usually pay a balance transfer fee – ranging from 3% to 5% of the amount transferred.
Summary: Guide to credit card interest
It’s important to understand the amount of credit card interest you’ll pay, and when it’ll be charged. This can help you to better manage your credit card debt and keep costs to a minimum. Most of what you need to know should be on your credit card statement.
The Financial Conduct Authority (FCA) is the regulatory body that oversees credit card providers in the UK if you’re unsure of the rules around interest charges.
