How and When is Credit Card Interest Charged? A Detailed Primer

Most people aim to keep their credit card cost at $0, especially rewards credit card users who work to optimize their credit card perks. Getting a credit card with no annual fee is a start at minimizing credit card costs.

Credit Card Terms

But rewards credit card users may feel the need to hit their monthly credit card costs somewhere, because the reward points are worth more than the interest they’ll owe on the balance. The result is that some credit card users end up paying hundreds of dollars in interest over a year on their reward points.

Knowing all the ins and outs of credit card interest will help reward card users decide how to maximize their rewards and minimize their credit card costs. Here’s what you need to know to keep your credit card expenses as low as possible.

Get the lowest APR possible. “Just because you pay nothing in annual fees, you have to get the best interest rate that you can,” says Nicholas Abadi, a credit card expert and money columnist for The Motley Fool.

How the Interest is Calculated

The best interest rate a credit card company offers is usually close to the average interest rate other lenders charge. But the average interest rate for credit card holders is known as the ‘TCU Rate.’ This rate is calculated by multiplying the average rate charged by the credit card issuer by the annual percentage rate (APR).

The APR is the amount of interest a consumer must pay in order to pay off a credit card balance. The APR is calculated using a debt-to-income ratio that represents the percent of the credit card balance a consumer can pay off each month.

Credit card companies prefer to have debt-to-income ratios below 36% to avoid credit score penalties.

Interest on Cash Advances

New credit card debt is often paid off by refinancing credit card debt with another credit card or personal loan. There are few fees to refinancing, but there can be interest costs on the interest that you paid on a new credit card.

Bankruptcy or bankruptcy risk can result from carrying high credit card debt, so most people simply prefer to pay their balance in full each month. At the end of the day, a balance of zero is better than a balance of $0.

Purchase Agreement Terms

On many credit card purchase agreements, you will find language that lists the transfer fee, and in many cases, the interest charge, for transferring a balance.

Minimum Payment, Maximum Time

On a good credit card, a relatively small balance accounts for only about 1 percent of overall credit card spending. That percentage increases with high-interest credit cards. Still, even low balances contribute about 10 percent of overall credit card spending. The average credit card user has a credit card balance of $4,867.

How Your Credit Card Works

It all comes down to this: You’re charged interest if your balance becomes over 5 percent of your credit card’s average monthly spending. What’s that percentage? It varies from card to card, but most cards have a limit of 5 percent.

Let’s use the popular Capital One Venture, for example. That’s the best-selling card in my book, and it has an average annual fee of just $25.

When is the Interest Charged?

Credit card interest is charged on what’s called the prime interest rate. The prime rate is the lowest interest rate that a bank can charge on a given day and will reset periodically. For example, if your credit card interest rate is currently 3%, then the prime rate will change to 5% or 7% by year’s end. Interest charges on credit cards are typically fixed rates, so the rate won’t change unless your credit card issuer increases or decreases your credit line (see below).

Credit card interest is usually charged on the amount of the credit line. In other words, your credit card issuer will only charge interest on the full balance of your credit card with a low limit, or they will charge interest on the balance with a higher limit.


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