How Do Credit Cards Charge Interest

Most people know that if they carry a balance on their credit cards beyond the due date they will have to pay interest. Understanding how interest is calculated on your credit card debt however can help you use credit more wisely and give you some tips on how to reduce your credit card balances sooner. how credit card interest works

What Is Your Grace Period

Credit cards typically offer you a 21 to 30 day interest-free grace period before they begin to calculate interest for ‘new purchases’.  There is a catch however.

  • There is no grace period if you do not pay your balance in full by the due date. Your balance includes all previous purchases, interest, cash advances, charges and new purchases. So even if you leave just a few pennies on your account unpaid you lose your grace period that month.
  • If you don’t pay your balance in full, your credit card company charges interest on all purchases all the way back to the original date of purchase.
  • There is never a grace period on cash advances, balance transfers or any form of ‘cash-like’ transaction. Interest on cash advances and similar activities is charged from the date the transaction occurred.

How Interest Is Calculated

Credit card companies calculate the amount of interest on your monthly statement in one of two ways:

  • by applying an average daily interest rate to your balance each day during your statement period and adding each day’s calculation together for one statement period, or
  • averaging your daily balance outstanding over your statement period and applying an average monthly interest rate.

What this effectively means is that the balance you owe each and every day affects how much interest you will pay. This has two implications for you if you carry a balance and want to get out of credit card debt:

  1. Every purchase you make adds to your average daily balance.
  2. Every payment you make decreases your average daily balance.

So the trick to paying off your credit card balances faster? Stop making purchases and make payments as often as you can. The sooner you do these two things, the sooner you will be free of the credit card interest cycle.

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