More than 175 million American households have at least one credit card, and Americans pay about $120 billion per year in credit card interest and fees — about $1,000 per year for each household.
These numbers take into account all types of interest that might be charged on credit cards — balance transfers or cash advances, for instance — but purchases likely make up the majority of most credit card balances. If you don’t pay your credit card balance in full every month, you’ll owe purchase interest.
What Is Credit Card Interest?
Credit card interest is what you’re charged by a credit card issuer when you don’t pay off your statement balance in full each month. Card issuers may charge different annual percentage rates (APRs) for different types of balances such as purchases, balance transfers, cash advances, and others. You may also be charged a penalty APR if you’re more than 60 days late with your payment.
An interest charge on purchases is the interest you are paying on the purchases you make with the credit card but don’t pay in full by the end of the billing cycle in which those purchases were made. The purchase interest charge is based on your credit card’s annual percentage rate (APR) and the total balance on that card — both of which can fluctuate.
Taking a closer look at your credit card balance and interest rate can help you figure out the best way to pay it off. Here’s some information about how purchase interest charges work and, in general, how interest works on a credit card.
How Does Credit Card Interest Work?
Credit cards charge different APRs on purchases, cash advances, and balance transfers. The cardmember agreement that was included when you first received your credit card outlines the different APRs and how they’re charged. This information is also included in brief on each monthly billing statement, or you can contact your credit card issuer’s customer service department for this information. Another place to find how interest works on various credit cards is through the Consumer Financial Protection Bureau, which maintains a database of credit card agreements from hundreds of card issuers.
Some credit cards offer an introductory 0% interest rate. But once that promotional period ends, paying your balance in full each month is how you can avoid interest charges.
For example, you get a new credit card with a $5,000 available credit limit and 0% interest for three months. You use the credit card to buy a new computer that costs $3,000 and a designer dog house for your poodle that costs $1,000.
For each of the three interest-free months you pay only the minimum balance due. But since the full balance hasn’t been paid, your fourth statement will include a purchase interest charge. That is the interest you now owe because you did not pay off your credit card statement balance in full.
Credit card interest is variable, based on the prime rate, and banks typically calculate interest daily. A typical interest calculation method used is the daily balance method.
• The bank will calculate the daily periodic rate, which is the APR divided by 365.
• To each day’s balance, the bank will add any interest charge from the previous day (compounded interest) and any new transactions and fees, then subtract any payments or credits. This is the new daily balance.
• The daily periodic rate is multiplied by the daily balance each day.
• At the end of the billing cycle, each day’s balance is added together, resulting in the amount of interest owed.
• If the amount owed is less than the minimum interest charge shown on the credit card’s fee schedule, the bank will charge the minimum.
You can make a payment toward your balance due at any time — you don’t have to wait until the due date. Since interest is commonly calculated daily, making multiple smaller payments rather than one large payment on the due date is one way to decrease the amount of interest you might owe at the end of the billing cycle. This can be a good strategy to use if you don’t pay your credit card bill in full each month. You’ll still owe some interest, but it may be less.
What is a Purchase Interest Charge?
Sometimes also known as a finance charge, an interest charge on purchases is simply interest you pay on your credit card balance for purchases you made but didn’t pay in full. If you don’t pay off your balance each billing cycle, a purchase interest charge for the unpaid amount then becomes part of the total balance you owe.
For example, let’s say you owe $1,000 on a credit card, and because you did not pay that $1,000 in full you were charged a purchase interest charge of $90. You now owe $1,090, and then the next month’s purchase interest charge will be calculated based on a balance of $1,090.
This is called compound interest and can lead to a cycle of credit card debt. The interest charges continue to accrue if you’re not paying your balance in full every month.
How Do You Get Rid of a Purchase Interest Charge?
For a temporary reprieve from paying an interest charge on purchases, you might look for a credit card that has an introductory 0% APR. Some credit card issuers offer introductory rates for anywhere from 12 to 18 months for qualified applicants. If you make a plan for paying off the balance before the promotional period ends and you’re diligent about sticking to it, you could forgo paying interest on purchases made during that period.
Some people might choose this strategy rather than taking out a personal loan for a specific purchase. If you’re sure you can pay the balance in full while the APR remains at 0%, it could be a good strategy.
The only sure way not to pay a purchase interest charge is to pay your credit card balance in full each month.
Different Types of Credit Card Interest
Interest charges on purchases are just one type of interest charged on a credit card. Other transactions and fees may apply and must be disclosed to credit card applicants. The information can be found in a credit card’s rates and fees table, often referred to as the “Schumer Box” after legislation introduced by Sen. Chuck Schumer as part of the Truth in Lending Act. The APR for purchases is typically at the top of the list, with others below.
• Balance transfer APR: If you transfer a balance from one credit card to another, this is the rate you’ll pay on the amount of the transfer. You’ll also be charged interest at this APR on any balance transfer fee your card issuer might charge you.
• Cash Advance APR and fee: Cash advance APRs tend to be much higher than purchase APRs, and there’s typically no grace period — interest starts accruing immediately. Like a balance transfer fee, you’ll be charged interest on a cash advance fee, too.
• Penalty APR: If your credit card payment is more than 60 days late, your credit card issuer may increase your APR. If you make the next six consecutive payments on time, the card issuer must reinstate your original APR on the outstanding balance. But they are allowed to keep the higher penalty APR on any new purchases.
In addition to interest charges, there may also be fees charged. All of these fees could potentially accrue interest at their respective rates if the credit card’s balance is not paid in full by the payment due date.
• Annual fee: Some credit cards charge an annual fee to the card holder.
• Balance transfer fee: A fee of 3% to 5%, typically, on the amount transferred.
• Cash advance fee: The greater of a flat dollar amount or a percentage of the cash advance.
• Foreign transaction fee: A percentage of each transaction amount, in U.S. dollars.
• Returned payment fee: Having insufficient funds in the bank account used to pay your credit card bill could result in a returned payment fee.
• Late payment fee: Payments made after the statement due date will incur a late fee of at least $29 and not more than $40.
Where Can I Find My Credit Card’s Interest Rates?
There are several places you can locate your credit card’s interests rates and fees.
Anytime you receive a solicitation for a credit card, which is basically an advertisement, the credit card issuer is required by law to disclose the card’s possible interest rates and fees, as well as how interest is calculated. Since the recipient of this advertisement hasn’t been approved for the credit at this point, these numbers are estimations.
If you are going through a prequalification process for a credit card, the issuer should be able to provide you with more specific APRs so you can decide if that card is a good financial tool for you.
After you’ve been approved, the credit card issuer will mail you a packet containing your physical credit card and detailed information in a cardmember agreement. It’s a good idea to read this document thoroughly so you’re aware of all possible APRs and fees you could be charged.
If you access your credit card account online, you can also find this same detailed information on the card issuer’s website. You can call the card’s customer service telephone number for the information.
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If you’re one of the many people who carry a credit card balance, knowing how much interest you’re paying on different types of charges is important. Interest charges on purchases are likely the most common interest charges, and the amount of interest you may pay can add up quickly.
To keep from paying interest on purchases at all, it’s important to pay your credit card balance in full each month. If you don’t, you’ll accrue interest, which compounds and can create a debt cycle.
Since credit card interest rates tend to be higher than other forms of credit, you may be considering paying off your credit cards with a financial tool that has a lower interest rate. A SoFi Personal Loan might be just the financial tool you’re looking for. With fixed, competitive rates and terms to fit many budgets, an unsecured personal loan from SoFi could make it easier to pay down your credit card debt. Instead of the recurring debt of a credit card, a personal loan has a payment end date so you’ll be able to plan for your financial future.
3 Personal Loan Tips
- Before agreeing to take out a personal loan from a lender, you should know if there are origination, prepayment, or other kinds of fees. If you get a personal loan from SoFi, there are no fees.
- If you’ve got high-interest credit card debt, a personal loan is one way to get control of it. But you’ll want to make sure the loan’s interest rate is much lower than the credit cards’ rates — and that you can make the monthly payments.
- Just as there are no free lunches, there are no guaranteed loans. So beware lenders who advertise them. If they are legitimate, they need to know your creditworthiness before offering you a loan.
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