Pamela Peredo

Editorial Disclosure: The editorial content on this page is not provided by any of the companies mentioned, and has not been reviewed, approved or otherwise endorsed by any of these entities. Opinions expressed here are the author’s alone.

Credit cards can be both a blessing a curse on your financial future. If you’re short on cash, and really need to make a purchase, a credit card can let you make the transaction and pay it back at a later date. If you have a credit card with excellent rewards, you may be earning cash back or reward points with every dollar spent. A credit card, when managed well, can be an excellent addition to your life. 

If you’re prone to leaving a balance on your card each month, however, credit card interest rates might be a term that sends a shudder down your spine. In addition to credit card fees, interest rates are the main drawback to owning a credit card, and can saddle many users with rapidly unsustainable levels of debt. 

According to the Federal Reserve, Americans’ revolving debt- the bulk of which is made up of credit card balances- exceeded $1 trillion in April 2019. This is the first time revolving debt hit the trillion-dollar threshold since the Great Recession in September 2017. 

For many, the difference between manageable and runaway credit card debt lies in the credit card interest rates a consumer has signed up to. This is the case now more than ever, with US consumers paying higher interest rates on their credit card balances than they have in more than a quarter-century. 

Unpacking US Credit Card Debt

So what is the average credit card debt, and how do you measure up? Here are some key statistics from the Federal Reserve: 

  • $1,154 in debt per card that doesn’t carry a balance;
  • $1,901 average balance on store credit cards;
  • $1,760 per account for adults with a credit report and Social Security number;
  • $5,554 per cardholder, excluding unused cards and store cards;
  • $5,673 per US adult with a credit card; and 
  • $6,506 average balance on credit cards at the end of 2018. 

The amount of average credit card debt held by Americans has been steadily increasing in the last decade, and many Americans feel no closer to paying off their debt than when they first opened their accounts. 

Thanks to credit card interest rates and fees, Americans were paying as much as $104 billion combined in 2018. This should come as no surprise, since the average interest rate on a credit card in May 2019 was a jaw-dropping 17%, while some credit card interest rates can run as high as 30%. If you’re finding it hard to manage your credit card debt, know that you’re not alone. 

Even so, if you’re planning to lower your debt levels, it might help to learn more about how interest rates work.

What is Interest? 

Interest is typically expressed as an annual percentage rate (APR), and is the fee paid for the service of borrowing money.

credit card interest rates

Credit card interest is only charged on the money owed at the end of each month. If you’re one of the fortunate, or savvy, consumers able to pay off their balance each month, then credit card interest rates are of little relevance to you. If you typically carry a balance at the end of the month, however, you will be hit with fees from your provider. 

Moreover, these charges can differ depending on what you charge to your credit card. If you make a cash advance or a balance transfer, you may be hit with higher credit card interest rates compared to simple purchases. In the same vein, some credit cards come with variable rates, which means that the interest rate on your card changes with the prime rate set by the Federal Reserve. If that rate goes up, so does the interest rate on your card. 

This is why it is vital that you read the terms and conditions behind your credit card interest rates before signing on that dotted line! 

How is Interest Calculated? 

The interest rate that you see on your statement is noted in annual terms. Your credit card provider will determine your purchases based on the daily rate, which is equal to your interest rate divided by 365. Your provider will then use that daily figure and multiply it by your balance at the end of each day. 

To understand how to calculate your APR, consider the following example: Jamie has a travel rewards credit card, and an average daily purchase balance of $1,5000 at the end of her 30-day billing cycle. Her card carries a variable purchase APR of 15.99%. 

Here’s how she calculates her interest charges: 

  1. First, she divides her APR by the number of days in the year. This looks like: 0.1599/365 = a daily periodic rate of 0.00044
  2. Then, Jamie multiplies the daily periodic rate by her average daily balance.  0.00044 x $1,500 = $0.66
  3. Finally, she multiplies this number the number of days in her credit card’s billing cycle. $0.66 x 30 = $19.80 interest charged for this billing cycle.

It required some working out, but the ultimate concept is simple: during months that you carry a balance, a cardholder will have to pay interest. 

A Tale of Two (Fixed) Interests 

If you’re still confused, consider the following scenario: 

Jack and Jill each have $2,000 debt on their credit cards, which requires a minimum payment of 3% or $10, whichever is higher. Both Jack and Jill are short on cash, but Jill still manages to pay an extra $10 on top of her minimum monthly payments. Jack, however, only pays the minimum repayment each month. 

Both Jack and Jill have a credit card interest rate of 20%, which applies to the balances on their cards. When they make their monthly payments, part of the payment goes toward paying interest, while another part is put toward the principal. 

Here is a breakdown of the first month of Jack’s credit card usage: 

  • $2,000 Principal
  • Payment of 3% of the balance, or $60 
  • Interest: $2,000 x 20% x 12 months = $33.33 
  • Principal repayment: $60 – $33.33 = $26.67
  • Remaining credit card balance of $1,973.33 ($2,000 – $26.67)

These calculations continue as above, each month, until Jack finally pays off his credit card debt. Ultimately, it takes Jack over 15 years, and $4,241 in total repayments, to pay off his $2,000 in credit debt. The interest Jack pays amounts to $2,241, which is higher than the debt he began with! 

Compare Jack’s situation with that of Jill. Because Jill pays an extra $10 per month, she pays a total of $3,276 over seven and a half years to repay her $2,000 in credit card debt. The total interest paid is $1,276. That extra $10 a month saves Jane close to $1,000 in repayments- such is the power of credit card interest rates! 

Fixed vs. Variable Interest Rates

Keep in mind that there are two basic types of credit card interest rates: fixed and variable. Fixed interest rates can only change under specific circumstances, and your credit card issuer must give you advance notice before changing your rate.

On the other hand, variable interest rates are tied to another interest rate- typically the prime rate set by the Federal Reserve. These types of credit card interest rates can change whenever the index rate changes, and your credit card issuer doesn’t need to give advance notice if your variable rate changes. Most credit card interest rates are variable. 

Different APRs 

Your credit card may have different APRs for different kinds of balances. These include: 

  • The purchase APR, or the interest rate applied to purchases you make with the card;
  • The balance transfer APR, or the interest rate applied on the balance transferred between credit cards; 
  • The cash advance APR, or the interest rate applied to the cash borrowed from your credit card. The cash advance APR tends to be higher, and often does not have any kind of grace period. 

As per the Consumer Financial Protection Bureau, “if you use your card to get a cash advance… generally you will start paying interest as of the date of the transaction.”

  • Your card may also carry an introductory APR, which is a temporary promotional APR offered in a bid to encourage you to sign up for the card. This can apply to purchases, or balance transfers, for a limited time. Often, the introductory APR is far lower than the card’s regular APR- sometimes as low as 0%!
  • A penalty APR could also be applied when you make late payments or violate your credit card’s other terms and conditions. This is typically the highest APR charged, and may be applied when your payment is more than 60 days late. 

Keep in mind that when you make a payment to a credit card that has different balances with different APRs, any amount above the minimum payment must be applied to the balance with the highest applied APR. 

The Bottom Line

Before you sign up for a credit card, be sure that you fully understand your credit card’s interest rates, whether they are variable or fixed, and which circumstances will allow your credit card provider to change your interest rates. 

Keep in mind that introductory APR periods rarely last forever. Further, a payment that is more than 60 days late could incur a penalty APR, leading to a higher interest rate for several months or longer. On the flip side, if you make six consecutive payments on time, you may be able to negotiate with your credit card provider to lower your rate. 

In general, paying your credit card off on time is good practice. The best way to avoid high credit card interest is to pay your balance in full and on time every month; if this seems out of reach, reconsider your need or ability to be a credit cardholder in first place. 

Ultimately, education is key. The better you understand your credit card interest rate, and how credit cards work, the better you can use your card to your advantage. Your new credit card can be both a blessing and a burden; ensuring your card has the lowest possible interest rate is still less important than ensuring you can pay off your balance on time as often as possible.

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