How credit card interest is actually calculated

This works through credit card interest in the order the parts actually depend on each other.

The interest-free period is conditional

A card offers up to around fifty-odd days interest free only if the previous statement was paid in full. Carrying any balance typically means new purchases attract interest immediately, with no grace period.

This is the single most expensive misunderstanding in card use, because people assume the grace period always applies. Restoring it usually requires clearing the balance in full and then keeping it clear for a further statement cycle, so one large payment does not switch the grace period back on immediately.

Interest accrues daily

Most issuers apply a daily periodic rate to the balance outstanding, then charge the accumulated total monthly. That means paying earlier in the cycle reduces interest, even if the total paid is unchanged.

It also means a large purchase early in a cycle costs more than the same purchase late in it. Some issuers calculate the charge from an average daily balance across the cycle rather than a running one, and the terms will say which, which decides whether paying early in the month helps at all.

Minimum payments are designed to persist

A minimum is typically a small percentage of the balance plus interest and fees, which falls as the balance falls. Paying only the minimum on a substantial balance can take decades and cost more in interest than the original spending. Regulators in several jurisdictions now require illustrations of this on statements, and they are worth reading.

Because the minimum is a percentage that shrinks as the balance shrinks, a standing order fixed at the current minimum clears the debt substantially faster than paying whatever each statement asks.

Not all balances cost the same

Cash advances usually attract a higher rate with no interest-free period and often a fee from the moment of withdrawal. Balance transfers, purchases and cash typically sit at different rates on the same card. Payment allocation rules in many jurisdictions require payments to clear the most expensive balance first, but only above the minimum.

For most people, spending in a foreign currency, and cash withdrawn abroad in particular, can combine the cash rate, a conversion fee and no grace period at once, which is how holiday spending on a card outruns the headline rate.

What to do with an existing balance

Stop using the card for new purchases while a balance persists, since the grace period is already lost. Pay materially above the minimum, and consider a transfer if the fee is less than the interest it avoids. Where the debt is unaffordable rather than merely large, free debt advice is a better first call than a transfer.

Persistent-debt rules in some jurisdictions oblige issuers to contact customers who have paid more in interest and charges than principal over a period and to offer a route out, and those letters are worth answering rather than filing.

The advertised rate is not always the rate you get

A representative APR only has to be given to a proportion of accepted applicants, so being offered a higher rate does not mean the advertisement was wrong. The APR also folds compulsory fees into one annualised figure, which makes it useful for comparing products and close to useless for predicting a single month of interest. Promotional and standard rates on the same card run separately, and a promotional period generally ends on a fixed date rather than a fixed time after your last transaction.

Where the issuer can vary the rate, the terms set out what notice you receive and whether you may reject the change and repay the existing balance at the old rate, which is a right many people do not know they hold.

The takeaway

Carrying a balance costs you the grace period on everything new. That is the real price.

The version you keep doing is the version that works.