How Does Credit Card Interest Accrue?

If you have a credit card, you might be wondering how is your credit card's interest calculated and how does it accrue. The post provides you with everything you need to know about how credit card interest accrues.

How Does Credit Card Interest Accrue?

If you don't pay your credit card in full at the end of your billing cycle, interest on your credit card balance accrues on a daily basis, meaning at the end of the day, you're charged interest on the balance and the interest charged becomes part of the balance at the end of the day. This continues throughout your billing period.

You can calculate the amount of interest you're being charged by dividing your APR by 365 days and then multiplying the resulting number by your current credit card balance. This should give you the amount of interest you owe on a daily basis.

For example, if you have a $1,000 credit card balance on a credit card with a 17% APR, you can calculate how much daily interest accrues by dividing 0.17 by 365 days, giving you $.000466. You then multiply your $1,000 by $0.000466, giving you a total of $0.466 of interest per day. To figure out your monthly interest rate multiply the resulting number by 30 days, giving you a total of $1,013.97 at the end of the month.

You can use this method to calculate how much interest accrues on your balance on a daily basis or a monthly basis.

CSP Pro Tip: That said, you should be careful when calculating the amount of interest you owe on a monthly basis because with some credit cards, interest compounds on a daily basis, meaning that at the end of the day, interest is charged and becomes part of the balance for the next day. This continues throughout your entire billing period, making it difficult for some people to pay off their credit cards. Calculating compounding interest can be quite complicated.

For those of you who are new to interest, interest refers to the amount of money that you will pay for borrowing money from your card issuer to purchase goods or services.

How Much Interest Are You Paying On Your Credit Card Balance?

You can figure out how much interest you're paying on your credit card balance by looking at the Annual Percentage Rate, also known as APR. APR is not standard among all cardholders. In fact, every person has a different APR, depending on his or her creditworthiness.

Although APR appears as an annual rate, credit card issuers apply the APR rate on your balance at a daily rate.

For example, if you have a credit card with an APR of 17%, this means that you will pay 17% of the balance on your credit card in interest. So, if you were to keep a balance of $1,000 on your credit card for a year, you would end up paying $170 in interest over the course of a year.

When Does Interest Begin Accruing On Your Credit Card?

Card issuers often give their cardholder a grace period during which to pay the entire balance before the due date. If the cardholder does not pay off the balance before the due date, interest begins accruing on the balance. So, if the balance is paid off by your credit card's due date, no interest is charged.

But, if you do not pay off the entire balance, interest begins accruing on the remaining amount that's due until it's ultimately paid off. In the event that you fail to make the payment, your card issuer may charge you a penalty interest rate that is significantly higher than your regular APR.

For example, if your regular APR is 15% and you fail to make your payment on time, your card issuer may charge you a penalty APR of 29.99% instead.

Card issuers and financial institutions know that most people leave a balance on their credit cards, and so interest is very lucrative for card issuers. In fact, American cardholders have more than $6,000 in credit card debt, so it makes sense to understand how credit card interest works.

Interest Accruing on Credit Card Cash Advances

If you use your credit card for regular purchases, you are charged the regular APR. However, if you make a cash advance, a separate, higher APR applies only to the amount you took out as a cash advance. For example, if you have a Bank of America Credit Card, the regular APR maybe 15.99% while the APR for cash advances may be 23.99%, making it significantly more expensive to use your credit card for a cash advance. In addition to paying a higher APR on cash advances, card issuers often charge a fee for taking out a cash advance, ranging from 3% to 5% of the cash advance amount. For example, if you were to take out a $1,000 cash advance, you may be charged $50 for the cash advance, and a higher interest may immediately apply to the cash advance amount.

How To Avoid Having Interest Accrue On Your Credit Card Balance?

You can avoid having interest accrue on your credit card balance by paying your balance before the due date. In fact, most credit card issuers provide cardholders with a grace period of approximately one month to pay off the balance. If the balance is paid off within the grace period, no interest accrues on the balance. However, if you leave a balance on your credit card, interest will begin accruing after the payment due date.

The second option to avoid paying interest on your credit card balance is to open a 0% APR credit card. There are many credit cards on the market that promise an introductory 0% APR credit card, allowing users to avoid paying interest on their credit card balance for a limited period of time that usually ranges from 6 months to 18 months. After the introductory APR period ends, you are required to pay interest on the balance left on the card.

In the event that you don't want to or cannot open a 0% APR credit card, you should consider paying more than the minimum payment on your credit card. Paying more than the minimum payment reduces the amount of interest you will pay on the balance while reducing the overall balance on your credit card.

Paying down the balance on your credit card will not only lower the amount of interest you pay, but it can also potentially improve your credit score.

This is so because paying down your credit card balance reduces your credit utilization. Your credit utilization makes up 30% of your credit score, the lower your credit utilization (how much of your available credit you're using), the better your credit score will be.

So, paying down the balance on your credit card can potentially improve your credit score in addition to reducing the amount of interest you pay on the balance.

What Factors Determine the APR On Your Credit Card?

The APR that will apply to your credit card depends on your creditworthiness. So, the higher your credit score and the higher your income, the better the APR that you will qualify. Likewise, having a low credit score may get you approved for a credit card, but your APR will likely be high. Typically, those who have excellent credit (740 or higher), will be approved for the lowest possible APR. However, if your credit score is less, you will usually pay a higher APR.

For example, a credit card issuer may advertise credit cards as having an APR of 11.99% to 20.99%, applications with the highest credit ratings will receive an APR at the lower end, while other applications will receive an APR towards the higher end of the spectrum.

How Can You Pay Off Your Credit Cards To Avoid Paying Interest?

You should pay your credit card bill before the payment due date. You should not wait until the day before the due date to pay your credit bill. Paying by the due date allows you to avoid paying any interest on your credit card balance.

Also, if you have the money, you should try paying off purchases as soon as you make them, or try making multiple payments throughout the month to keep your credit card balance at a minimum.

If you don't have the funds to pay off your credit card entirely, you should explore the option of applying for a balance transfer card with 0% APR. A balance transfer card can be a great tool to pay off your credit card balance quickly. This is so because by transferring your balance to a credit card that does not charge interest, more of the money you pay towards lowering your balance rather than going towards interest. This helps you quickly pay down your balance while costing you less money.

Frequently Asked Questions (FAQs)

1. Is credit card interest added daily?

Yes, most card issuers compound interest on a daily basis, meaning you're charged interest on a daily basis and that interest is added to the balance. You then pay interest on the entire balance, including the newly added interest. This process continues as long as you carry a balance on your credit card.

2. Do I get charged interest if I only pay the minimum payment?

If you only pay the minimum payment on your credit, leaving a balance on your credit card, you will pay interest on the remaining balance if it's not paid off by your payment due date. If you pay the balance before your due date, you will not be charged any interest. But, if you pay after your due date, you will be charged interest.

3. Is credit card interest compounded daily or monthly?

Most credit card issuers compound interest on a daily basis, making it expensive to carry a balance on your credit card. To avoid paying a lot of interest, you should strive to pay off your credit card at the end of the month before the payment due date to avoid paying any interest.

4. What is the usual minimum payment for a credit card?

The minimum payment on your credit card is usually 1% to 2% of your credit card balance if your balance exceeds $1,000. Typically, if your balance is below $1,000 you're minimum payment will be set as a minimum of $25. Paying only the minimum payment on your credit card makes it very difficult to pay off your balance within a short period of time. For this reason, most card issuers recommend making more than the minimum payment on your credit card.


How Does Compound Interest Work?

Whether you're investing money or calculating the amount of interest on your loan, you may be wondering what compound interest is and how it works? We will explain what compound interest is, as well as how it works in much detail below.

How Does Compound Interest Work?

Compound interest, commonly known as compounding interest, works by adding the interest to a principal amount, and then calculating interest on the principal amount as well as the interest that you have previously accumulated. The simplest way to explain compound interest is that it's interest on principal + interest.

For example, if you have a savings account and you deposit $1,000 into your savings account at a 5% interest rate that's compounded annually, at the end of your first years, you will have $1050 in your account. The next year, the amount you will earn interest on is $1050 (principal + interest) because you've added the interest to your principal amount.

However, if you had simple interest instead of compound interest, you would only earn interest on the initial $1,000 that you had deposited into your savings account and the interest would be set aside, you would not earn interest on your interest.

So, if you have money in your savings, you would want compound interest because it can exponentially increase the amount of money you're saving because you're getting interest on the principal amount that you saved, as well as interest or the interest you've earned.

On the other hand, with simple interest, interest is only calculated on the original principal, you will not earn interest on your interest. You can still make money, but you will not have the exponential growth that you have with compound interest.

The number of times interest is compounded depends on your financial institution. Some banks may choose daily compounding, monthly compounding, quarterly compounding, or annual compounding.

The type of compounding is different from one bank to another. For example, Bank of America and Wells Fargo compound interest on a daily basis, however, other banks, such as Chase, compound interest monthly.

The more frequently a bank compounds interest, the more money you'll make on your savings. So, if you were to deposit the same sum of money with Bank of America and Chase at the same interest rate, you will make more money with Bank of America than you would with chase.

Compound Interest on Debt

Now that you know that compound interest is great when you're saving money, when you're trying to pay off debt, you do not want compounded interest. This is so because when you're paying off debt if the interest on the debt is compounded, you will end up paying more to borrow money because you're essentially being charged interest on a larger sum of money every month.

How to Calculate Compound Interest?

The formula for compound interest is as follows:

A = P(1+r/n)nt

  • A - Refers to the amount of money that you will have at the end
  • P - Refers to the principal amount of money that you're starting off with
  • R - Refers to the annual interest rate you've been offered
  • N - Refers to the number of times your interest rate compounds every year
  • T - Refers to the total number of years you are planning on earning interest on your money

For example, If you wanted to place $10,000 in your checking account at a 5% interest for a 5 year period compounded annually, the formula would look as follows:

A = $10,000(1 + .05/1)(1)(5)

A = $12,762.82

With the same example, if your interest was not compounded, you would use the following simple interest rate formula, which would yield the following result:

A = P(1 + RT)

A = $10,000 (1 + .05 x 5)

A = $12,500

So, as you can see from the formula above, by saving money in a savings account that uses compounded interest, you will save more money ($262.82). That said, you may believe this amount is small, but as the amount of money increases, the yields will become much higher.

Note: We were compounding interest on an annual basis, the more frequently your interest compounds, the more money you'll be earning on money in your savings account.

Why Does Money Grow More Quickly With Compound Interest?

People who are saving using a savings account that offers compound interest can grow their money more quickly than those relying on simple interest. This is so because you're earning money on the principal amount that you've invested, as well as the interest that's added to that amount. The more frequently your interest compounds, the more money you'll be able to earn.

Some banks, such as Bank of America and Wells Fargo compound interest on a daily basis, whereas other banks such as Chase, compound interest on an annual basis. So, the bigger the sum of money that you're saving the more money you'll earn in the long run.

For example, if you were to place $100,000 in an account that only offers simple interest at a rate of 5% for 10 years, you would earn $50,000 in interest. However, if the same amount of money at the same interest rate were to be placed in an account with compound interest, you would earn approximately $63,000 during the same ten year period. This is an increase of over 24% in earning by simply switching to a compounding interest account instead of a simple interest account.

How Frequently Does Compounding Interest Compound?

The frequency of which your interest compounds is different from one financial institution to another. For savings accounts, most banks have adopted daily compounding, where the interest you've earned in any given day is added to your principal amount, allowing you to earn interest on your interest.

That said, for a CD account, interest may compound on a daily basis, monthly basis, or semi annual basis. For money market account, interest usually compounds on a daily basis. That said, to determine how often your interest rate compounds, you should contact your financial institution and ask them about your specific account.

Credit Score Planet Frequently Asked Questions

1. Is compound interest good?

If you are saving money, compound interest is a great thing to have because it can exponentially increase the growth of your money. However, if you have compound interest on a loan, you do not want compound interest because it means that you'll end up paying more money to pay down your balance.

2. How does compound interest work?

Compound interest works by allowing you to earn money on not only the principal amount that you've saved but also interest on the interest you've earned. The more frequently that your interest compounds, the more money you'll be able to earn.

3. How does compound interest on a daily basis work?

Compound interest on a daily basis works by adding the interest that you've earned on your principal balance to the principal itself at the end of each day, so that the following day you earn interest on the principal amount, as well as the interest you've earned in previous periods.

4. Can I double my money with compound interest in three years?

Although you may be able to double your money with compound interest, you probably will not be able to do in three years unless you have an extremely high interest rate, which is very rare.