What Is an Interest Charge on a Credit Card?

Credit card interest represents the cost of borrowing money from a credit card issuer. This financial charge applies when a cardholder does not pay their full outstanding balance by the due date. Essentially, it is the fee paid for the convenience of using the credit card company’s funds beyond the initial billing cycle. Understanding this fundamental concept is the first step toward managing credit card accounts effectively and avoiding unnecessary expenses.

Credit Card Annual Percentage Rate

The Annual Percentage Rate (APR) is the yearly cost of borrowing money, expressed as a percentage. This rate serves as the primary factor in determining the interest charges applied to a credit card balance. Different types of APRs exist, depending on the nature of the transaction.

The purchase APR is the standard rate applied to new purchases. Cash advance APRs, typically higher, apply when you withdraw cash using your credit card. Balance transfer APRs are rates applied to balances moved from one credit card to another. A penalty APR is a higher rate that may be imposed if a cardholder makes late payments or violates other terms of the cardholder agreement. Issuers must provide a 45-day notice before applying a penalty APR.

APRs can be either fixed or variable. A fixed-rate APR remains constant unless conditions are met or the issuer provides advance notice of a change. Variable APRs can fluctuate over time. These rates are tied to an underlying index, such as the prime rate, meaning they will increase or decrease as that index changes.

Calculating Interest Charges

Credit card interest charges are calculated using the Annual Percentage Rate (APR) and the average daily balance method. The APR is converted into a Daily Periodic Rate (DPR) by dividing it by 365 days to determine the daily interest rate. For example, a 24% APR would translate to a DPR of approximately 0.06575% (0.24 / 365) per day.

The Average Daily Balance (ADB) method is how card issuers determine the balance on which interest is charged. This method involves tracking the outstanding balance for each day within a billing cycle. New purchases, payments, or credits are factored into the daily balance as they occur.

To calculate the ADB, the daily balances for each day of the billing cycle are summed, then divided by the number of days in that billing cycle. For instance, if the sum of daily balances over a 30-day billing cycle is $9,000, the ADB would be $300 ($9,000 / 30). This ADB is then multiplied by the Daily Periodic Rate and the number of days in the billing cycle to arrive at the total interest charge for that period. This compounding process means that interest accrues daily and is added to the principal, leading to a higher balance on which future interest is calculated.

Grace Periods and Interest Accrual

A grace period is a timeframe during which interest is not charged on new credit card purchases. This period extends from the end of a billing cycle to the payment due date, allowing cardholders to avoid interest if they pay their full outstanding balance from the previous cycle by the due date. Federal regulations require credit card statements to be mailed or delivered at least 21 days before the payment due date, defining the minimum grace period length.

To maintain an interest-free grace period, the cardholder must pay the entire statement balance in full each month. If the full balance is not paid, the grace period is lost, and interest begins accruing on new purchases from the date of transaction. This means that carrying a balance can result in immediate interest charges on subsequent purchases.

Grace periods apply only to new purchases. They do not extend to other types of transactions, such as cash advances or balance transfers. Interest on cash advances and balance transfers begins accruing immediately from the transaction date. Making only the minimum payment will not preserve the grace period, leading to ongoing interest accrual on the remaining balance and any new purchases.