Contributing Writer at Tally
March 31, 2021
The average credit card debt for the American cardholder in 2020 was $5,315, according to Experian's 2020 Consumer Credit Review. Debt can grow quickly on credit cards because of high annual percentage rates (APRs) and compounding interest. When interest charges compound, your lender charges you interest on top of the interest you've already accumulated.
However, this doesn’t mean you should avoid credit cards completely. When used correctly, you can earn cash back or travel points by using something like a rewards credit card. And balance transfer cards can help pay down existing debt. Using a credit card responsibly allows you to build your credit score, making it easier to do things like get approved for a mortgage or a car loan in the future.
Knowing how credit card interest works allows you to use your card to your advantage. To help you do this, we’ll answer the question, "When do credit cards charge interest?" We’ll also cover how your purchases and your APR impact your interest charges.
Interest is what a credit card issuer charges you for borrowing money from them. In return, you have access to funds when they otherwise may not have been available.
For instance, let's say your car breaks down, and the repairs are going to cost $2,000. You don’t have enough money to cover the cost, but you need to have it repaired immediately so that you can go to work and pick your kids up from school.
So, you put the expense on a credit card. The credit card issuer lends you $2,000, which you can use immediately. However, the lender sets a due date for you to pay this money back. If you do not pay the full balance by the due date, your credit card company charges you interest. The amount you are charged depends on your interest rate.
You may be wondering, “When are you charged interest on a credit card?” The simple answer is that lenders charge interest if you do not pay your entire credit card balance by the due date. But let’s take a closer look.
Your billing cycle (also known as your billing period) is the length of time between monthly statements. Your monthly statement — or credit card bill — will provide the following information:
Balance: This is the total amount that you’ve borrowed and owe back to your credit card company.
Minimum payment: This is the minimum amount you must pay to avoid penalties like a late fee. Keep in mind, if you only pay the minimum payment, you are still charged interest on your unpaid balance.
Due date: This is when your minimum payment is due. If you pay the balance in full by this date, you will also avoid interest charges.
Grace period: This is the number of days you are given to pay the statement balance, which by law must be at least 21 days. While the grace period may not be explicitly mentioned on your statement, you can calculate it by counting the number of days between your closing date and your due date.
Purchase APR (or regular APR): This is the rate at which your lender charges interest if you make your minimum payment but still have a balance.
Penalty APR: This is the rate at which your lender charges interest if you miss minimum payments. The penalty APR is a higher interest rate than the purchase APR.
For example, let's say that you receive your statement on April 7. You have a balance of $500 due on April 28. The minimum payment is $25.
If you only make the minimum payment, your outstanding balance is $475. On April 29, you are charged interest on your $475 balance. The interest charged is based on the purchase APR, otherwise known as your regular APR.
If you do not make the minimum payment, your lender applies late fees to your current balance. Let’s say the late fee is $25, so your balance increases from $500 to $525. Then, the lender charges you interest on the $525 balance. The penalty APR is then applied, so the amount of interest your lender charges you increases.
There are three scenarios when a credit card company will not charge interest.
If you receive your statement and pay the entire balance by the due date, the credit card company will not charge you interest.
It's also possible for you to pay your balance before the billing cycle is closed. For example, your billing cycle ends April 6. You made $500 in purchases on March 25 but pay it down in full on April 4. You end the cycle with a $0 balance, so your lender does not issue a minimum payment or amount due. You are not charged interest.
Similarly, if you have a zero balance because you did not put any charges on the card during that billing cycle, you are not charged interest.
Lastly, you are not charged interest if you have a 0% promotional APR. Promotional APRs are lower interest rates offered to cardholders when opening new credit card accounts. You may have up to nearly two years to pay off your balance under a promotional APR before a lender charges interest.
However, many lenders also provide a disclaimer that states if you miss a minimum payment, the promotional APR is void, and you are immediately charged full interest. So, interest is not charged with a 0% promotional APR for the duration of the promotional period, so long as you make minimum payments.
To calculate how much your lender charges in interest, you need to know your:
Average daily balance.
The number of days in your billing cycle.
Start by dividing your APR by the number of days in a year. For instance, if your APR is 16.99%, divide .1699 by 365. This gives you the daily periodic rate of 0.00046.
Then, determine your average daily balance. This is calculated by first adding your balance from each day of your billing cycle and then dividing that total by the number of days in your billing cycle.
For example, let’s say you have a 30-day billing cycle. For the first 15 days you have a $0 balance each day, and for the last 15 days, you have a $1,000 balance. If you add each day’s balance together, you get a total of $15,000. Divide that total by 30 days. This gives you the average daily balance of $500.
Next, multiply your daily periodic rate by your average daily balance. In our example, you’d multiply 0.00046 by $500. This gives you a daily interest charge of $0.23. Multiply this by the number of days in your billing cycle to find out the total amount of interest charged. So, if you have a 30-day billing cycle, you’d multiply 30 by $0.23. The total interest charged would be $6.90.
If you do not pay any of your balance or the interest before the next billing cycle, your new balance will be $506.90. You'd repeat the above calculation to determine your new interest charges. This demonstrates how compounding interest works at a basic level, as you're charged interest on top of interest. This example does not account for things like late fees, penalty APRs, cash advance APRs or variable APRs.
Understanding when companies charge credit card interest can help keep you out of debt. High-interest credit cards can compound your debt, making it more difficult to make payments.
If you don’t want your credit card company to charge you interest, paying your balance in full is the way to go. You can either do this before your billing cycle is complete or before your due date. If you’re unable to pay your balance in full, you’ll be charged interest. But making the minimum payment can help you avoid late fees or an even higher interest rate.
If you are charged interest and find yourself struggling to get out of debt, be sure to look into a credit card payoff app like Tally. Tally automates your credit card payments, paying your balances in the most efficient way possible while also ensuring you make all of your minimum payments. In doing so, you can improve your payment history on your credit report while getting yourself out of debt quickly.