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How does credit card interest rate work

By Royal Bank of Canada

Published July 3, 2024 • 7 Min Read

How does credit card interest work

Credit cards are a fast, easy, and convenient way to make purchases, access cash, and manage expenses— but result in interest if they are not paid on time. Interest may continue to build on recurring statements if you don’t manage your account appropriately.

Here’s the lowdown on interest, how it works, and how to control it.

What is interest and when is it charged?

It’s what credit card companies charge for lending you money to make purchases or borrow money right now. There are two different types of interest: purchase interest and cash interest. Purchase interest is charged when you buy something with your credit card, while cash interest is charged when you borrow money against your credit card.

How do credit card interest rates work?

Take a closer look at your credit card statement and you’ll see it has both a cut-off (closing) date and a due date. The cut-off date signals the end of your previous 30-day billing cycle and the start of the next. The due date is the date by which you must make a minimum payment. 

For example, your statement might show a billing cycle from January 5 to February 5 and a payment due date of February 26. As long as you pay off your statement in full by the February 26 due date, you will not be charged for purchases made between January 5 and February 5. This 21-day period between the cut-off date and the statement purchase date is known as the interest-free grace period.

If you make purchases on your credit card and pay off your statement in full by the statement due date, you won’t be charged any interest. In other words, interest is only charged if you don’t pay your statement balance by the due date.

However, if you carry a balance, pay late—or both—you’ll see an interest charge on your following monthly statement labelled as purchase interest.

You’re also charged interest when you borrow money against your credit card, a cash advance. In that case, the interest is charged from the transaction date and accrues until the balance is paid in full. Cash advances are not covered under the interest-free grace period and incur interest charges right away. These will show up on your monthly statement as cash advance interest.

If you lack sufficient funds to pay your balance in full, you can opt to pay the minimum required by the due date, which appears on your statement. Paying on time ensures you maintain a good credit rating and avoid late payment charges, which can appear as additional interest. You will still be charged interest on the balance. However, as long as you don’t let your balance grow indefinitely, this can be a helpful option for managing expenses when cash is in short supply.   

Another option for managing expenses is taking advantage of the interest-free grace period. Suppose you have a credit card payment coming due at the end of the month, but you need to make a substantial purchase at the beginning of the month. If you can wait a few days until the cut-off date to make your purchase has passed, you can defer payment of it until the end of the following month. 

What is credit card interest rate?

Interest on credit cards is typically expressed as an annual percentage rate or APR. Though it’s expressed as a yearly percentage, it’s calculated daily. This is known as your periodic daily rate. This periodic daily rate is calculated by dividing the APR by the number of days in a year. This amount is then multiplied by the average daily balance on your credit card and then multiplied by the number of days (30) in your billing cycle.

Suppose you carry an average daily balance of $1,000 and your credit card with an APR of 19.99%. Here’s how you would calculate your monthly interest.   

First, divide your APR by the number of days in a year:

            0.1999 / 365 = 0.00054 daily periodic rate

Then multiply the daily periodic rate by the average daily balance of $1,000:

            0.00054 X $1,000 = .54

Multiply this by the number of days in your billing cycle:

            .54 X 30 = $16.43

$16.43 is the amount of interest that will appear on your next month’s statement and be added to your existing balance.

This interest would kick in from the date of the transaction. For example, if you made the purchase on February 1 and your statement date is February 26, the interest would be calculated from the original transaction date. This is known as reach back.

Credit card rates

Standard credit card APRs in Canada tend to run between 19.99% and 25.99%.

Some cards come with a variable APR that will fluctuate with a certain benchmark, like the prime rate.

Most other cards have a fixed APR, meaning it generally doesn’t fluctuate.  

It’s not uncommon for cards to charge multiple APR interest rates—one on purchases, another (usually higher) one on cash advances, and still another on balance transfers.

There are also low-interest credit cards available that come with lower APRs, typically between 8.99% to 12.99%. These can be helpful to people with existing higher balances looking to pay lower interest or for people who prefer simple credit cards with no additional perks.

Variable rate cards are another low-interest option, but they come with variable APRs.

Many credit cards offer promotional lower APRs to encourage sign-up, but these tend to be available for a limited time and subject to certain conditions. Many cards offering balance transfers come with extra fees known as balance transfer fees, which can range from 2% to 5% of the amount transferred, in addition to interest. Before signing up for a credit card, you should read the fine print to learn your card’s APR and terms and conditions.

Looking to save on interest rate?

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Impact of carrying balances at high interests on credit

Credit card interest rates in Canada tend to run between 19.99% and 25.99%. At these high-interest rates, letting your credit card balance get out of control can put you in a situation where you continuously owe a lot of money on your credit card and are paying high interest on it month after month.

How to avoid paying high credit card interest

The surest way to avoid paying high interest on credit cards is to pay off the full balance as it appears on your statement on time each month. Depending on your circumstances, that may not always be possible. In that case, here are some tips to minimize your credit card interest:

Pay more than the minimum

Paying down more than the minimum will help bring your balance down faster, along with the interest you get charged.

Don’t wait until your payment is due.

If you are carrying a balance from month to month, pay what you can as soon as you can. The lower your balance today, the lower your interest tomorrow.

Look into low-interest credit cards.

You may be eligible for a lower-interest credit card if you pay your minimum balance on time and have a good overall credit score.

Say yes to balance transfer offers.

Take advantage of a limited-time promotional balance transfer offer and try to pay off as much as possible during that promo period.  

Set reminders.

Life gets busy, and it’s sometimes easy to pay your credit card bill on time. Setting reminders on your calendar helps you avoid being late with your payment and incurring an additional interest charge. Paying off the minimum will keep you in good standing. And if you are late and it’s a one-off event, don’t panic. If you reach out to your bank, they may be able to help you.  

A credit card is a helpful financial tool, offering multiple benefits like flexibility, rewards, and cash back. Maximize these benefits by understanding how credit card interest works and managing it well.

This article is intended as general information only and is not to be relied upon as constituting legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. Information presented is believed to be factual and up-to-date but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or any of its affiliates.

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