How does credit card interest work?

A credit card charges interest on the balance you carry past the due date, at roughly your APR divided by 12 each month. Pay the full statement balance by the due date and purchases usually cost no interest, but carry a balance and the interest is added to what you owe, so next month you pay interest on the interest too.

Divide the APR by 12

An APR is a yearly rate. A 24% APR works out to about 2% a month, so a $3,000 balance carried for one month costs about $60 in interest.

Pay in full to keep the grace period

Most cards give you a grace period on new purchases. If you pay the full statement balance by the due date, you owe no interest on those purchases. Pay less and interest starts to build.

Minimum payments are mostly interest

A minimum payment is set so the account stays current, not so the debt goes away quickly. On a high-rate card, most of each minimum payment goes to interest in the early months.

Interest compounds on a carried balance

Unpaid interest becomes part of your balance. The next month's interest is charged on that larger number, which is why a carried balance grows faster than it looks.

What the APR means

APR stands for annual percentage rate. It is the yearly cost of borrowing on the card, shown on your statement and in your card agreement. Most cards have a variable APR that follows the prime rate.

A single card can carry more than one APR. Purchases have one rate, cash advances usually have a higher one, and a balance transfer might have a low promotional rate for a set number of months. Your statement must list each balance type and the APR that applies to it.

From a yearly rate to a monthly charge

To see what a month of carrying a balance costs, divide the APR by 12. A 24% APR is 24% ÷ 12 = 2% a month. On a $3,000 balance, that is $3,000 × 2% = $60.

Many issuers actually work it out by the day. They use a daily periodic rate (the APR divided by 365, or by 360 at some issuers) and apply it to your average daily balance for the billing cycle. A 24% APR is about 0.066% a day. The result lands close to the monthly figure, but paying earlier in the cycle lowers your average daily balance and trims the interest a little.

The examples and tables on this page use the simpler monthly method (APR ÷ 12 on the balance at the start of each month). Your real statement will differ by a few cents or dollars, depending on when you buy and pay.

How the grace period works

A grace period is the time between the end of a billing cycle and the payment due date. By law, your bill has to reach you at least 21 days before the due date. If your card has a grace period and you pay the full statement balance by that date, new purchases cost you nothing in interest.

The grace period usually applies only if you paid in full last month too. Once you carry any balance, new purchases often start charging interest from the day you make them. You usually need to pay in full for one or two cycles in a row to get the grace period back. Cash advances typically have no grace period at all.

How minimum payments are set

Each issuer sets its own minimum payment formula, and it is in your card agreement. A common style is 1% of the balance plus that month's interest and any fees, with a floor such as $25. Others use a flat percentage of the balance, such as 2% or 3%. The calculator and tables here assume 1% plus interest with a $25 floor, so treat them as an example, not your exact bill.

Because the minimum shrinks as the balance shrinks, paying only the minimum stretches the debt over many years. Your statement includes a minimum payment warning box that shows how long payoff would take at the minimum and what a payment that clears the debt in three years would be.

Why a carried balance snowballs

When you pay less than the full balance, the unpaid interest joins the principal. Next month, the card charges interest on that new, larger amount. That is compounding, and it works against you on debt the same way it works for you on savings.

The fix is a fixed payment above the minimum that you don't let shrink. When you pay more than the minimum, issuers must generally put the extra toward the balance with the highest APR first, which helps if you have a cash advance or an expired promotional rate on the same card.