If you’re carrying a balance on your credit card, even a small one, you’re paying interest. But if you understand how credit card interest works, you can avoid the most common pitfalls and behaviors that get many borrowers into financial trouble.

Here’s what you need to know:

How does credit card interest work?

Simply put, your credit card’s APR (annual percentage rate) is either a fixed or variable rate a lender charges you to borrow money over a one-year period.

Depending on your card’s terms and conditions, you’ll likely have one or the other.

Fixed APR

Your annual percentage rate will remain the same while you have your credit card. However, there could be some fluctuations in certain circumstances, such as if your payment is made more than 60 days past the due date or if you had an introductory offer and it expires.

Variable APR

Your annual percentage rate can and will change based on market fluctuations.

Calculating Your APR

You know that your APR will factor into your payments somewhere, but how does it actually apply to your credit card balance? Credit card companies typically use a daily percentage rate to figure out how much interest to charge you. To do this, they divide the APR on your credit card by 365 to account for each day of the year. This gives them your daily percentage rate. Whatever your credit card balance is at the end of each day, this will be multiplied by your daily interest rate to come up with your daily interest charge. Your daily interest charge is added to your credit card balance, and that total is what you will start the new day with. However, you will not see the daily interest charge on your statement, but rather the total monthly interest rate.

Here’s an example:

APR: 15.6%

15.6%/365 = 0.00042739726 (your daily percentage rate)

Today’s balance on your credit card: $1,500

0.00042739726 x $1,500 = 0.64109589041 (your daily interest charge)

Tomorrow’s starting balance: $1,500.64

Although $0.64 doesn’t seem like a lot of money, these daily interest charges will add up throughout the month until the end of your credit card’s billing cycle.

Interest Beyond APR 

Your credit card will also likely have different APRs for different types of uses. For example, the purchase APR is simple enough — it’s the interest rate applied to purchases you made with your credit card.

Other APRs include:

Balance transfer APR

If you transfer the balance of one credit card to another, this APR is the interest rate that will be applied to the transferred balance.

Cash advance APR

Applies if your credit card allows for cash advances. It is the interest rate that is applied to the amount that you borrow from your credit card.

Introductory APR

May be offered by a credit card company as an incentive to sign up for the card. This APR only lasts for a limited period of time.

Penalty APR

The interest that will be charged if you make a late payment or violate your credit card’s terms and conditions in some other way.

When do credit cards charge interest?

Credit cards can be a great way to build credit and improve your credit score. Fortunately, you can achieve this without paying interest on your credit card. The secret is to be smart about your payments.

Your credit card runs on a monthly billing cycle. However, that doesn’t mean you need to make a payment on your credit card before your billing cycle closes. Most credit cards will automatically grant you a grace period that runs between the close of your billing cycle and your payment’s due date.

For example, you may have a billing cycle that runs from September 25th to October 25th. At the end of your billing cycle, you’ll have a statement balance of whatever it is you spent throughout the billing cycle. If you have balance or interest from previous billing cycles left unpaid, those may be included in your statement balance as well. You’ll then have a grace period from the closing of your billing cycle to a future due date, such as November 4th.

When you make your payment, you’ll likely see a few automated options. There may be a minimum payment of, say, $25.00. Then you might have a statement balance of $356, and a current balance of $409.

For most credit cards, to avoid paying interest, you need to pay your statement balance each month by the due date.  When a statement balance is not paid in full the interest will roll over into the next billing cycle and will require 2 months of the statement balance being paid in full to alleviate the interest.  For example, if you pay only the minimum payment by the due date for January you will have interest on your statement in February, accrued in January. If you then pay the February statement in full you will have interest on the March statement because of the carried balance from February.  If you continue paying the balance in full each month, starting in March you will no longer be charged interest.

Your current balance is your statement balance plus whatever purchases you’ve made since the grace period started. You can pay the current balance if you’d like. If you don’t, the amount that you accrued during the grace period will be due at the end of your next billing cycle.

Keep in mind, though, that if you made a balance transfer or took out a cash advance, those interest charges may still apply. Be sure to check with your lender regarding the details of your account.

How to save on credit card interest

The bottom line here is this — as long as you pay your full statement balance by the due date each month, you should be able to avoid paying interest on your credit card purchases.

Now you know how interest works, you’re well on your way to building a better credit score and financial future.

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