Simply Explain it to Me: Credit Card Interest

Estimated read time: 2 minutes

Credit Cards can seem confusing at first glance, or even on a second glance. All of the different terms like APR, annual fees, billing cycles, and of course credit card interest seem foreign and are buried in the contract you sign to become a credit card holder. Let's break down credit card interest and explain how it affects you and your balance.

First let's define the terms:

APR– Stands for annual percentage rate. This is the percentage of interest that you are charged on an annual basis if you maintain a balance on your card.
Annual Fees– These are fees charged for the use of the card, charged once annually. This charge has no effect on interest rate.
Billing Cycles– the billing cycle is the amount of tie you have between credit card statements and when interest will be charged. Most credit card billing cycles are between 25-28 days.
Credit Card Interest– This is the amount billed to you each billing cycle based on your APR. If you have a balance when the billing cycle ends, you will be charged with interest based on the amount you have spent.

Daily Interest Rate

Now that we know what the major terms mean, we can determine how they determine what to charge us. The APR is the annual amount of interest, but each billing cycle they determine how much interest to charge you based on a daily interest rate.

For example: If you have an APR of 15% you will be charged a daily interest rate of .041096%. This daily interest rate is then used to determine how much you will be charged in interest. Because this is a daily interest rate, it is calculated daily on what your balance is.

When the billing cycle ends, each daily charge is added up to get the amount of interest you will owe on that credit card statement.

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Avoid Paying Interest

You can avoid paying interest entirely if you are able to pay off the entire balance of the card before the billing cycle ends. It is a good idea to make sure you are managing your balance effectively, and paying it off entirely.

Credit card companies make a large amount of their revenue from the interest they charge you on a monthly basis. Now, armed with your knowledge of credit card interest, you can pay no interest and feel good about your credit habits.

Interest Is Not Bad

While you can get away with not paying interest, part of the reason you have a credit card is to delay paying for specific purchases. The credit card companies are just asking for a percentage to compensate them for the use of this money.

If you need two or more months to pay down a balance, that is perfectly fine. Paying this interest isn't a bad thing, it just means that you are paying for the time that you are using to pay back the balance. Just pay the balance at your first opportunity to avoid interest building up over time.