How does credit card interest work?

Borrowing money typically comes at a cost. When it comes to credit cards, the lender will charge you interest on any money that you borrow and don’t repay in full every month. If you want to keep your credit card costs to a minimum or avoid paying more than necessary, then it’s critical to understand how credit card interest works.

What is credit card interest?

In the simplest terms, credit card interest is the cost of borrowing money with a credit card. If you use a credit card and don’t pay your entire outstanding balance at the end of your billing period, the lender will charge you interest on your balance.

This interest is usually expressed as a yearly rate, which is known as the annual percentage rate (APR). APRs on credit cards typically range from about 5% to over 30%. Generally speaking, the lower the APR, the lower the cost of borrowing.

What are the different types of credit card interest?

Most cards have several types of interest rates. Here are the five main rates you need to be aware of.

1. Introductory rate

Many credit cards have an introductory period during which you can benefit from a low or even a 0% interest rate for a specific period. During this period, you can carry a balance without incurring interest as long as you make the minimum required payment.

2. Purchase transfer rate

This is the interest rate charged for new purchases that you make on your card and that you do not pay off in full before the end of the card’s grace period. The ‘grace period’ is the time between the end of your billing cycle and your bill’s due date.

3. Balance transfer rate

This is the interest rate charged on any balance transferred from one credit card to another. Unlike the purchase rate, there is no grace period when it comes to the balance transfer rate. Interest is usually charged from the date you make the transfer unless there is a 0% introductory rate for balance transfers on your card.

4. Cash advance rate

This is the interest rate charged when you withdraw cash from your credit card. The cash advance rate is usually higher than the purchase and balance transfer rates. There is also no grace period and interest is charged from the day you withdraw the cash.

5. Penalty rate

Some cards may also charge you a penalty rate if you are late with your payments or if you miss a payment entirely.

What determines a card’s interest rate?

The interest rate on a credit card is determined by a number of factors. Your credit history is one. Consumers with a good credit history usually get the best credit card interest rates.

The type of credit card can also have an impact on the interest rate. A reward credit card, for example, will have a higher rate.

The interest rate on a credit card can also be fixed or variable. A fixed interest rate means that the card’s rate remains the same month to month, though it could change under certain circumstances.

A variable interest rate means that the card’s rate will fluctuate in line with the Bank of England’s base rate. A variable rate can also change for other reasons, such as if you miss a monthly payment. The average credit card interest rates in the UK have been increasing over the past year, but that shouldn’t affect you too much if you plan to pay off your balance each month.

Where can I find my interest rate?

You can find your interest rate on the disclosure statement for your credit card account and on your monthly credit card statement.

How is credit card interest calculated?

If you apply for a credit card that has an APR of 19%, you might assume that you’ll be charged interest at 19% each year. However, that is not the case.

Most credit cards actually compound your interest daily. That means interest is added to your principal balance at the end of every day.

Credit card interest is calculated by multiplying your average daily balance by the daily rate, which is your card’s APR divided by 365 (the number of days in a year). This is then multiplied by the number of days in your billing cycle to determine your interest charges for that particular billing cycle.

How can you avoid paying interest?

The simplest way to avoid paying interest is by paying your outstanding balance in full and on time.

If you can’t avoid paying interest, then there are ways to reduce your charges.

If you have a good credit score, for example, you can qualify for a card with a lower interest rate. You can also significantly reduce the amount of interest you’ll pay by making more than the minimum payment.

If you’re looking to get a credit card with a low interest rate, check out our list of our top picks for rewards and cashback credit cards in the UK to find the best fit for you.