With credit cards, you can enjoy a generous amount of rewards and benefits as long as you are responsible with them. However, if you don't pay off your balance every month, they can be dangerous to your finances because you'll end up paying interest, which makes it difficult to pay off your debt.
Therefore, it is imperative that you understand when interest is charged to your credit card balance so that you know how to avoid them. By doing that, you are getting the most value from your credit cards. Otherwise, interest charges can end up costing you more money than the value gained from rewards and benefits.
When is Interest Charged?
Your credit card issuer charges interest if you still carry a balance after the grace period. This is the certain period of time after the statement cycle ends when your balance is not accruing interest. According to federal law, you're entitled to a grace period of at least 21 days. The last day of the grace period is usually considered your monthly payment due date.
Note: Balance transfers and cash advance transactions don't usually have a grace period. Rather, interest is likely to accrue interest immediately, even if you had a $0 account balance. We recommend that balances from these transactions be paid off as soon as possible, especially with cash advances (they tend to carry higher APRs).
You don’t automatically get charged interest when you make a purchase using a credit card. If you were, then credit cards would be far too expensive to be worth using, except in dire emergencies. Instead, you have a certain amount of time from the time when you make a purchase to pay it off without incurring interest.
Know your statement cycle
Getting a grasp of your card's monthly statement cycles is key to understanding how and when interest is charged to your specific account.
Example: Let’s assume that your statement cycle ends on the 1st of every month and you currently have a $0 balance.
You make a $50 purchase on the 3rd of February. Then, you make a $25 purchase on the 15th and a $25 purchase on the 20th. Your statement closes on March 1st, with a total balance of $100.
You’ll get a bill for your statement balance of $100 with a due date for payment. Pay off the entire balance and you will not see interest charges applied on the next month's credit card bill.
Assuming you pay the full amount by the due date, you’ve effectively received an interest-free loan from the credit card company.
If by the due date, you have not paid the full balance, interest will begin to accrue on the remaining balance. You will also forfeit the grace period on purchases you make going forward. If you already have a balance on your credit card, any purchases you make will start to accrue interest charges immediately. That makes using the card even more expensive if you already have a balance on it.
How is Interest Calculated?
The calculation used to determine how much interest is charged seems difficult, but the math is relatively simple. It just requires a few steps to get all the information you need.
- Figure out the daily periodic interest rate (DPR). You can do this by taking your card’s annual percentage rate (APR) and dividing it by 365. So, if you have a card that charges an APR of 20.99%, your DPR is 0.0575%.
- Calculate your average daily balance on the card. This is more difficult because you need to account for any payments or purchases you make. To keep the math simple, let’s assume you had a $500 balance for the first15 days of the statement period, and then made a $250 purchase, increasing your balance to $750 for the next 15 days.
Your daily average balance for the thirty-day statement period would be:
((500 x 15) + (750 x 15)) / 30 = $625
- Multiply your average daily balance by the DPR, then multiply the result by the number of days in the statement. So, in this case, with a DPR of 0.0575%, a 30-day statement period, and an average daily balance of $625, the result is:
625 x 0.000575 x 30 = $10.78
While interest charges of just $10.78 might not seem like a lot, it adds up very quickly. If you make just the minimum payment, it could take years and hundreds of dollars in interest to pay your debt off completely.
Interest Charges Even When You Have a $0 Balance
It is possible for you to be charged interest even if you have a $0 balance when your statement arrives. This is known as residual interest.
The reason residual interest charges occur is that interest charges are based on your daily average balance. If you carry a $1,000 balance for the first five days of your statement period, then pay it off, your bill will arrive with a $0 balance, but also include interest charges. Despite the fact that your balance at statement closing was $0, you’ll still owe interest for the first five days of the statement period.
To avoid getting charged residual interest, make sure you always pay your card off in full. Residual interest only occurs if you carry a balance from statement to statement. If you do carry a balance and plan to pay the card off in full, call the lender to request an exact payoff amount that will cover your balance and interest.
How to Avoid Paying Interest
Now that we’ve covered the situations in which you may be charged interest, we’ll discuss how to avoid interest charges.
Pay off your entire balance before the due date
The most obvious, and easiest, way to avoid interest charges is to always pay your balance in full before your due date. Credit card issuers only charge interest when you carry a balance from month to month, or you use your card for a cash advance. So long as you only use your card for purchases and pay your bill in full every time, you’ll never pay any interest.
The easiest way to do this is to sign up for automatic payments on your card issuers website. When you do this, the card issuer will automatically pull the full statement balance amount from your checking account each month. You don’t even have to think about making payments. Just spend money on the card and the money will automatically be removed from your bank account.
Get a 0% APR introductory rate
If you want to make a large purchase and want a few months to pay it off, you can use a credit card and pay no interest, assuming you plan ahead.
Many credit cards offer perks and sign-up bonuses to entice customers into opening an account. Often times these rewards come in the form of airline miles, points, or cash back. Other cards offer promotional interest rates as their sign-up bonus.
If you opt to open one of these accounts, you can get between 12 and 21 months of use out of the card without being charged any interest. The only requirement is that you make at least the minimum payment each month. If you miss a payment, interest will begin accruing.
Using one of these deals is a good way to get a short-term interest free loan, but it can be dangerous. If you fail to pay off the balance before the promotional period ends, interest will start accruing. With how much interest credit cards charge, you can find yourself paying a lot of interest very quickly.
Transfer your balance to a 0% intro rate card
If you’re already carrying a balance on a credit card, you can get out of the cycle of interest charges by transferring the balance to another card with a 0% interest rate period.
Open a credit card with a promotional period of no interest, as described above. Then, follow the process that the new card’s issuer offers to transfer an existing card’s balance to the new card. Many card issuers have cards that specifically target people who want to make balance transfers, so finding one should not be hard.
Balance transfers often cost money. Usually, the cost is a percentage of the balance transferred. However, the best balance transfer credit cards offer both no-fee balance transfers and no-interest promotional periods for balance transfers made soon after the account opens. Take advantage of one of those deals if possible to get the maximum savings.
As before, make sure to pay off the full balance before the promotional period ends. If you don’t the interest charges on whatever balance remains will quickly add up.
Credit cards are incredibly useful for day to day life. Without them, it’d be difficult to make online purchases and you would need to carry around huge sums of cash in day-to-day life. Knowing how, why, and when interest is charged will make it easier for you to take advantage of their benefits.