The Ultimate Guide to Credit Cards
Thursday, May 30, 2024

What Is a Credit Card Interest Rate? Types of Rates & Debt Impacts

What Is A Credit Card Interest Rate
Eric Bank

Written by: Eric Bank

Eric Bank
Eric Bank

Eric Bank is an M.B.A. who has covered financial and business topics since 1985, appearing regularly on Credible, eHow, WiseBread, The Nest, Zacks, Chron, BadCredit.org and dozens of other outlets. Eric specializes in taking complex subject matters and explaining them in simple terms for consumer audiences, particularly in the world of personal finance. Eric holds a Master's in Business Administration from New York University and a Master's in Finance from DePaul University.

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Edited by: Jon McDonald

Jon McDonald
Jon McDonald

Jon leverages 15-plus years of journalism expertise to inform financial consumers about emerging trends and companies making an impact in the industry. He is most knowledgeable in the areas of budgeting, credit card rewards, and responsible credit use. Jon has a passion for writing and editing, and his articles have appeared in publications produced by The New York Times.

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Reviewed by: Andrew Allen

Andrew Allen
Andrew Allen

For nearly 20 years, Andrew has worked for financial institutions ranging from regional investment organizations to some of the largest banks in the world. At Wells Fargo, Andrew was a Consultant within the Insight and Innovation division. A graduate of the University of Georgia’s Terry College of Business, Andrew’s goal has been promoting personal financial wellness and solid money decisions.

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Opinions expressed here are ours alone, and are not provided, endorsed, or approved by any issuer. Our articles follow strict editorial guidelines and are updated regularly.

A credit card interest rate is the price you pay to borrow money from a credit card issuer. When you use a credit card to buy something (or take out cash) and you don’t pay back the full amount you owe right away, the credit card company charges you interest. 

The additional amount the issuer requires you to pay depends on your interest rate. The higher the interest rate, the more money you have to pay back in addition to what you borrowed.

In this guide, I’ll explain interest rates, including the Annual Percentage Rate (APR), how it is calculated, and when it applies. By the end, you should understand how credit card interest works — and how to avoid it.

Types of Interest Rates on Credit Cards

Your Annual Percentage Rate and your actual interest rate may be different. Think of your APR as the basic (or nominal) interest rate. It’s a simple version of what you pay. But the real interest rate you pay, called the effective interest rate, includes more than just the basic number.

The main difference between your nominal interest rate and your effective interest rate is how your credit card manages compound interest. Since credit cards usually add interest to your balance every day (i.e., daily compounding), not just once a month or year, the APR doesn’t tell you everything. The effective annual percentage rate (EAR or EAPR), which includes these daily charges, really shows what you pay.

APR disclosure example
Card issuers communicate a card’s APR through transparent disclosures.

Your credit card will probably have different APRs for different types of charges. You’ll need to check your cardholder agreement to know which APR applies to each category.

This agreement comes with your new card, and you can download it from the issuer’s website. The document tells you which interest rate applies in each situation.

Purchase APR

The purchase APR is very important because it applies to the purchases you make with your card. Your cardmember agreement usually lists this rate first. If you get a special promotion with a lower interest rate, or 0% APR, for new purchases when you get the card, the purchase APR you see will be the rate that starts after the promotional period ends.

Your purchase APR depends largely on current interest rates and your credit history, as well as your FICO credit score and other factors.

Factors that Influence Purchase APRs

  • Current Interest Rates
  • Cardholder Credit History
  • Cardholder FICO Credit Score

As I’ll explain below, you can avoid paying the purchase APR if you repay your entire monthly balance by the due date.

Note that credit cards often use the same APR for purchases and balance transfers, if available, but this is not always the case. Read on for more information about balance transfers later on.

Promotional APR

A credit card with a 0% introductory APR offer is a great choice when new cardmembers need more time to pay off a purchase. These cards typically give you six to 21 months from account opening without charging interest on new purchases and/or balance transfers. 

This means you won’t pay extra to carry certain balances during the introductory period. Avoiding interest charges makes it easier to manage (and pay off) large purchases and/or balance transfers without additional cost.

Variable APR

In most cases, your credit card doesn’t have a fixed APR. These credit card APRs are variable, meaning they can go up or down during the year. This change is often reflected in the Wall Street Journal Prime Rate (WSJ Prime Rate).

WSJ prime rate table
The Wall Street Journal tracks bank rate information to publish the WSJ Prime Rate. Source: wsj.com

The WSJ Prime Rate, as I explain below, takes into account the prime rates from the 30 largest US banks.

Fixed APR

A fixed APR means your interest rate stays the same, not changing with the prime rate or inflation. This usually makes a fixed APR higher than an initial variable rate because it offers stability in your payments. However, fixed rates can still change in certain situations. 

For example, your credit card company may raise your APR if you miss payments or your credit score drops. The credit card company must give you written notice 45 days before it applies a new rate. Your monthly statement should also inform you about any changes to your payments in advance.

Cash Advance APR

A credit card cash advance lets you use part of your credit line to get cash. You can do this at an ATM, just as with a debit card, but the money comes from your credit card instead of your bank account.

Cash advances start accruing interest right away. This makes them more expensive because of the high cash advance APR and accompanying fees.

Chase cash advance APR example
Cash advance APRs are typically higher than purchase APRs.

The interest rate for cash advances (cash advance APR) is typically higher than for purchases. For example, while the average purchase APR may be around 22.89%, the APR for cash advances can be as high as 36%, with an average of around 24.89%.

This is why it’s best to use cash advances only in emergencies.

Penalty APR

Penalty APRs are higher interest rates that credit card issuers can charge if you miss payments or break other terms of your card agreement. You can avoid these higher rates by making every payment on time and following all card rules. A typical penalty APR is 29.9% when the purchase APR is below this level.

If you do get hit with a penalty APR, some credit cards offer ways to reduce your debt or switch back to the normal APR after meeting certain conditions, including making several on-time payments in a row. Other cards make the penalty APR virtually permanent.

Some credit cards don’t have penalty APRs at all, so they can be a safer choice if you’re concerned about accidentally triggering a higher rate. Choosing these cards can give you peace of mind.

How Credit Card Issuers Set Interest Rates

Credit card companies decide how much interest to charge based on a few factors. The credit card APR you qualify for depends on a mix of timing and your credit history. The following factors apply:

  • Your Credit Score: This score shows how well you’ve managed money and bills in the past. A better score may mean you pay less interest because the company thinks you’re good at repaying them.
  • Prime Rate: This is a special rate that banks use, mostly for their best customers. Credit card interest rates often vary with this rate.
  • Rules and Laws: Certain regulations determine how credit card companies can set or change interest rates.
  • The Economy: Factors include how much things cost (inflation) and how many people want to borrow money.
  • What the Issuer Wants: Each credit card company has its own strategy. Some may offer lower interest to attract more cardholders, while others may have higher rates but deliver more rewards.

Credit card companies must declare your interest rates in the card agreement you sign so you know what to expect.

The Role of the Prime Rate

Although the government doesn’t set the prime rate, the Federal Reserve’s federal funds rate influences it. The WSJ Prime Rate (the rate that sheds the most light on credit card APRs) typically sits about three points above the federal funds rate. Changes to the federal funds rate can make the prime rate go up or down. 

For example, after the 2008 recession, the prime rate was very low and started rising in 2015. Currently, it’s at around 5.5%, and the WSJ Prime Rate is approximately 8.5%.

historical prime rate graphic
The prime rate has steadily increased since 2022. Source: St. Louis Federal Reserve

Big banks adjust their prime rates when the Federal Reserve changes the federal funds rate. Once most big banks (at least 23 out of 30) have changed their rates, the WSJ updates its Prime Rate. If the WSJ Prime Rate goes up, your variable credit card APR likely will, too. 

Assessing Your Credit History and Income

Your credit history determines your credit score, which in turn helps credit card issuers set your APR. Your income can also influence how issuers decide what rates to offer you. Let’s take a closer look at the roles these factors play.

Credit Scores

When credit card companies offer you a card, they show a range of possible interest rates. For example, the card may specify an APR range of 13.99% to 22.99%. Where you fall in that range depends on your credit score (typically, your FICO score) and other factors that show your risk. Issuers typically disclose your exact rate only after you actually apply for the card. 

credit score ranges

If your FICO score is very good (740 to 799) or exceptional (800 to 850), you may have an APR of 16% to 18%. For good credit scores (670 to 739), the APRs may range from 20% to 22%. For fair credit scores (580 to 669), the APRs start getting higher, typically between 22% and 24%. Lastly, if you have poor credit (350 to 579), the APRs are the highest, starting at 24% but going as high as 36%.

Your credit limit also depends, to some extent, on your credit score. Cards for consumers with bad credit usually have low credit limits, often less than $1,000. The credit limit tells you how much you can charge on your credit card. 

Income

Your income affects your credit limit, as well. When an issuer is thinking about approving you for a credit card, it often checks how much money you make. That’s because the institution wants to be sure that you can pay back any money you borrow. 

Your credit report doesn’t list your income, so when you apply for a credit card, you report how much you earn on the application. This helps issuers decide how much credit they feel comfortable extending. 

DTI calculation example
Card issuers seek to understand a prospective cardholder’s debt-to-income ratio.

Some card issuers may ask you to show them your pay stubs or tax returns to double-check your income. This helps them understand if you have too much debt compared to how much you earn (i.e., your debt-to-income ratio). 

A good DTI ratio is less than 36%, meaning your debts should be at most 36% of your income. You may get approved for a higher credit limit if you have a good income and a low DTI ratio, 

Credit-Boosting Tips

You could qualify for a higher credit limit and lower APR if you can boost your credit score. Several methods require a significant amount of time and effort, including fixing errors on your credit reports and paying your bills on time every month. Nonetheless, these are vital activities that you should undertake.

But you can do a few things to quickly improve your credit score. One of the fastest ways is to pay down your credit card balances. This is helpful if you often have a large balance on your card each month. The amount you owe on your cards impacts a significant percentage of your credit score. So, less debt means a better score.

Another handy tip is to keep your unpaid balances on each card under 30% of the total limit. For example, if Jose has a credit limit of $5,000 on his card and he owes $1,000, his credit utilization ratio is 20%. That’s good because it’s under 30%.

credit card utilization table
Credit utilization rates impact consumer credit scores.

Also, try to pay your entire credit card bill before the statement date ends. Whatever amount shows in your statement is what the card reports to the credit bureaus. Early payment may help you bump up your score.

You may have a low credit score because you have made some late payments. You should focus on doing whatever you can to ensure you don’t miss payments. This is vital because how often you make payments on time is a big part of your credit score — it counts for 35% of it.

Talk to the credit card company if you may miss a payment because money is tight. It may help you find a way to pay later without hurting your score.

Using technology can help you stay on top of this by setting up automatic payments from your bank account. This means the money for your credit card bills will automatically go out on time. You can even set these payments to happen before they’re due. This helps because it keeps your balance low when your issuer reports your credit use.

Making multiple payments within your billing cycle can also be smart. It lowers the balance that gets reported and reduces the interest you pay since it lowers the average daily debt.

And tools, such as Experian Boost, may allow you to add details to your credit report, which can help improve your score.

These tools connect to your bank account and look for bill payments such as your phone, utilities, or cable. If you’ve been paying these bills on time, adding this info to your credit report could help increase your credit score quickly.

Experian boost screenshot
Experian Boost can help consumers raise their Experian credit score.

Before this technology increased access, only banks or similar businesses could add this kind of data to your credit reports. Now, you may have the opportunity to add your utility payment records to your report, and this can help boost your score.

Experian Boost is one of several similar products that broaden the information that goes into your credit report. Also check out alternatives such as StellarFi, TurboTenant, and UltraFICO to see which ones best suit your spending habits.

Other Factors Considered

When the economy is humming along, people and businesses tend to spend more. More people are working and have money to spend, and they are optimistic about their financial prospects.

During economic expansion, many consumers want to borrow money through loans and credit cards for things such as houses and cars or to grow their businesses. These conditions make interest rates rise because the Federal Reserve needs to curb inflation. At the same time, banks see the opportunity to charge more for loans. 

The Effects of Economic Expansion

  • Consumers borrow money to finance personal and business pursuits.
  • Interest rates rise as the Federal Reserve aims to restrain inflation.
  • Lenders charge borrowers more for loans.

On the other hand, when the economy is not doing well, people and businesses tend to spend less, and the demand for credit falls. People may save more than they spend. In times like these, the Federal Reserve and banks often lower interest rates to encourage people to borrow more money. Lower interest rates can reduce credit card APRs, prompting people to use credit for big purchases or to keep their businesses afloat.

In short, economic conditions influence interest rates and help balance how much money the population borrows and spends. 

Another factor affecting credit card interest rates is competition among issuers. Credit card companies often change their APR to compete with each other and attract more customers. If one credit card company offers a lower APR, others tend to lower their rates, too, so they don’t lose customers. This competition helps keep the rates fair.

Also, each credit card issuer has its own rules about how it sets APRs. Issuers look at how much it costs to operate and how much profit they need to make.

They may increase APRs if their costs go up. However, if they want to grow market share, they may lower APRs despite these costs.

How to Calculate Credit Card Interest

Credit card companies calculate interest using formulas that depend on APR, average daily balance, and daily compounding. The formulas are straightforward enough so that you can check their math if you want.

Average Daily Balance

The average daily balance (ADB) is a way credit card companies figure out how much interest you owe if you don’t pay off your card right away. Here’s how it works: Every day, the company looks at how much you owe on your credit card and keeps a record. At the end of the month-long period, which is called a billing cycle, they add up all these daily amounts and then divide them by the number of days in the cycle. This gives them your ADB for the cycle.

A billing cycle is just the time from one monthly statement to the next. During this period, the card tracks every transaction and fee. At the end of the cycle, the credit card company sends you a statement. This statement lists everything you bought, any fees or interest you owe, and the minimum and total amounts to pay.

Here’s an easy way to figure out your ADB using the following formula:

Average daily balance (ADB) = Total of all daily balances divided by the number of days in the billing cycle

The steps to calculate ADB are:

  1. Keep Track Every Day: Write down what you owe on your credit card at the end of each day. Remember to include any new purchases or payments.
  1. Add Them Up: At the end of the billing cycle, add up all these daily amounts.
  1. Divide: Now, take the total you just added and divide it by the number of days in the billing cycle (for example, 30 days).

Imagine your billing cycle is 30 days, and the following activity occurred:

  • Day 1-10: Your balance is $200 due to a purchase on Day 1.
  • Day 11: You pay $100, so your balance drops to $100.
  • Day 12-20: Your balance stays at $100.
  • Day 21: You buy something for $400, raising your balance to $500.
  • Day 22-30: Your balance stays at $500.

Now, calculate the total of your daily balances:

  • Days 1-10: 10 days x $200 = $2,000
  • Days 11-20: 10 days x $100 = $1,000
  • Days 21-30: 10 days x $500 = $5,000
  • Total: $2,000 + $1,000 + $5,000 = $8,000

To find the ADB:

  • ADB: $8,000 / 30 days = $266.67

This $266.67 is the average amount you owe each day over the 30 days. If you don’t pay off your entire balance by the due date, the credit card company will use this average to calculate how much interest you need to pay.

Credit card companies can use alternate methods to calculate interest, such as adjusted balances and previous balances. However, these alternatives are less fair than the ADB method for reasons I’ll explain below, so issuers seldom use them. 

It’s also important to know about the daily periodic rate to understand how credit card companies figure out how much interest you owe. Here’s how it works:

  1. Daily Periodic Rate (DPR): This is the APR divided by 365 days. However, some credit card companies use the bank-year convention (or 30/360 method) of 360 days instead of 365.
  1. Interest for the Billing Cycle: You get this by multiplying the ADB by the daily periodic rate and by the number of days in the billing cycle.

For example, suppose your ADB is $266.67 for a 30-day billing cycle, and your APR is 24.99%:

  • First, calculate the DPR: 24.99% divided by 365 = 0.06847% per day.
  • Then, find out the interest for the 30 days: $266.67 x 0.0006847 x 30 = $5.48 in interest per day.

This shows you how the APR, your daily balances, and when you make transactions and payments can impact how much interest you pay on your credit card.

The timing and length of your credit card’s billing cycle can affect your interest charges, too. Here are a few key things to keep in mind:

  • Length of the Billing Cycle: The number of days in the billing cycle can make a difference. A longer billing cycle means each day’s balance has slightly less impact on your average balance for the month. So, a high balance for a few days in a long cycle (i.e., 31 days) will impact your average balance slightly less than it would in a shorter cycle (i.e., 30 or 29 days).
  • Timing of Transactions: The timing of when you buy something or pay off part of your balance can change your ADB. If you make a big purchase at the beginning of the cycle, it will affect your balance for more days than if you make it at the end. Similarly, paying off some of your balance early in the cycle can help lower your ADB more than making a payment later on.
  • Start Date of the Billing Cycle: Your billing cycle start date can also make a difference. If it begins just after you typically make a large monthly purchase or bill payment, it could increase your average balance for that month. If it starts before you usually spend, you may see a lower average balance when you pay it down.

Understanding these factors can help you plan when to make purchases or payments to reduce the amount of interest you may owe.

Other Calculation Methods

The way credit card issuers figure out how much interest you owe can vary. Here’s a look at three different methods they may use:

  1. Average Daily Balance (ADB) Method: This is the most common method. As detailed above, it calculates interest based on the average amount you owe each day during the billing cycle. It reflects your actual card use over the month.
  2. Daily Balance Method: This method is rare. It charges interest on the amount you owe at the end of each day, which could end up costing you more in interest compared to the average daily balance method because it doesn’t use an average.
  3. Previous Balance Method: Issuers infrequently use this method because it’s not very fair. It calculates interest based on the balance at the end of the last billing cycle without considering any payments you’ve made since then. Most credit card companies avoid using this method because it can lead to higher interest charges that don’t reflect your current usage.

Here is a chart comparing the three methods of assessing balances:

METHODDESCRIPTIONIMPACT OF PAYMENTSSUITABILITY
Average Daily Balance (ADB)Calculates interest by averaging the balances recorded each day over the billing cycle.Payments reduce the balance for later days, lowering the average balance and potential interest.Suitable for those who carry a balance and make regular payments throughout the billing period.
Daily Balance MethodCalculates interest by applying the daily interest rate to each day’s full balance, then summing up.Payments immediately lower the balance and reduce the interest for subsequent days.It helps those who pay off their balances quickly after making new charges.
Previous Balance MethodIt calculates interest based on the balance at the end of the previous billing cycle, regardless of changes during the current cycle.Payments do not affect interest charges in the current cycle, as they hinge on the previous cycle’s ending balance.It may not reflect current spending or payment habits, which is potentially unfair to those who pay off their balance.

You can check which method your credit card uses by reading your cardmember agreement. The issuer must spell out how it computes your interest charges in the document.

How to Avoid Paying Interest

You can avoid or reduce the interest your credit card charges on purchases in several ways. For example, keeping your ADB low reduces the amount of interest you pay. Here are a few strategies that can help you minimize your interest charges.

Pay Off the Full Balance During the Grace Period

The grace period on a credit card is free time to pay for your purchases without extra costs. It starts after your billing cycle ends (i.e., the statement end date) and usually lasts about 21 to 28 days, depending on your card. The last day of the period is the payment due date. You won’t pay any interest on purchases if you pay all you owe by this date.

Not all credit cards have a grace period, so it’s a good idea to look at your card agreement to see if yours does and how long it is.

example of card terms and conditions
Issuers must disclose the grace period in their terms and conditions — if they offer one.

Suppose you only pay off some things by the due date and carry some debt into the next billing cycle. In that case, you’ll start getting charged interest right away on your balance and new purchases. To stop this and gain back your interest-free grace period, you need to pay off everything you owe.

Remember, the grace period doesn’t cover cash advances — interest on these starts building up immediately.

Make Payments Above the Minimum

You can reduce your card’s total balance faster when you pay more than the minimum amount each month. This is good because it means you’re not just covering the interest; you’re actually paying down the total amount you owe.

By reducing your balance quicker, you also reduce the amount of interest that piles up. Since credit cards calculate interest on the remaining balance, a smaller balance means less interest will accumulate. Over time, this can save you a lot of money that would otherwise go to interest charges.

Paying more than the minimum may also strengthen your credit profile and show lenders that you can manage your debt. 

Keeping your balance low compared to your total credit limit also improves your credit utilization ratio, which is a big factor in calculating your credit score. In the long run, responsible behavior can help you maintain a healthier credit profile and make it easier to get approved for loans with better rates in the future.

Use Balance Transfers and Promotional Rates

A balance transfer allows you to move your existing debt from one or more credit cards to another card. You can do this to benefit from a lower rate or even 0% introductory APR on the new card, which can help you pay off your debt faster by saving money on interest charges. 

balance transfer facts graphic

By transferring multiple balances to a single card, you can also streamline many monthly payments into one, making it easier to manage your finances. This can be a smart strategy if you’re looking to reduce the amount you pay in interest and get a handle on your debt.

When a credit card offers new cardowners an introductory 0% APR on purchases or balance transfers, it means you won’t pay interest on the money you spend or the balances you move to that card for a set period.

Here’s what you need to know about these promotional offers:

  • Promotional Period: This is how long the 0% interest rate will last. It typically ranges from six to 21 months. Make sure you know when this period ends because, after that, the interest rate will jump to the card’s regular rate.
  • Eligible Transactions: For purchases, any new eligible items you buy with the card won’t generate interest during the promo period. For balance transfers, any debt you move from another card won’t gather interest until the promotion expires. Check for specific conditions, including having to complete transfers by a certain deadline after you open the account.
  • Fees: Even if there’s no interest, you will pay a transaction fee for transferring a balance. This fee is a percentage of the amount you transfer (typically 3% to 5%). Knowing this helps you figure out if transferring a balance is worth it.
  • Payment Requirements: You still need to make minimum monthly payments on time during the 0% APR period. Missing a payment can terminate the promotional rate early, and you’ll start accumulating interest on your balance right away.
  • Impact on Credit Score: Using a lot of your available credit, even at 0% APR, can affect your credit score. Try to keep the balance low compared to your total credit limit. And if you transfer balances from other cards, don’t run up a bunch of charges on them. That defeats the purpose of transferring your balance to another card with a lower interest rate

Understanding these terms will help you make the most of a 0% APR offer without unexpected surprises when the promotional period ends.

Many cards charge the same regular APR for purchases and balance transfers. You can verify this by checking your cardmember agreement. The regular APR kicks in on any unpaid transferred balances remaining after an introductory promotion expires.

The Impact of Interest Rates on Credit Card Debt

When you use a credit card, you can repay the money you spend quickly or over an extended period. You need to know about interest rates if you choose to repay your balance slowly or take a cash advance. These rates determine how much debt you accumulate on your credit card.

How Compounding Interest Works

Compounding interest means that you pay interest not only on the money you borrowed but also on any interest that the account has already added to your balance. This can make your debt grow faster, especially if you only pay the minimum amount due each month.

Let’s compare the impact of daily compounding in an example. Suppose you owed your credit card issuer $2,000 over two months without any transactions during the period. The card’s APR is 20%, and it has no penalty APR. Leaving out late fees, the debt with daily compounding would be:

$2,000 × (1 + 0.20 / 365) ^ 60 = $2,066.83

In the 20% APR example, the daily compounded rate accumulates for 60 days. Compare the debt to the case in which no compounding occurs (i.e., simple interest):

$2,000 + ($2,000 × (0.20 / 365) ​× 60) = $2,065.75

In this case, the extra $1.08 in interest due to compounding is negligible. It would have a greater impact if the amount owed was much larger.

Now, notice what happens if we assume the credit card charged a 36% APR instead of 20%, using the same formulas:

  • Debt after two months with daily compounding = $2,121.87
  • Debt after two months with no compounding = $2,118.36

The difference of $3.51 (i.e., $2,121.87 –  $2,118.36) due solely to compounding at the 36% APR is small. Once again, the impact would be greater if the debt were larger.

However, the compounded interest at the 36% APR is $55.04 greater than that at 20% (i.e., $2,121.87 – $2,066.83). Clearly, the difference in APRs swamps the effect of compounding alone.

But compounding can still make the amount you owe on a credit card grow faster, especially if you only pay the minimum due each month. Here are some strategies to reduce the impact of compounding on your debt:

  • Pay More Than the Minimum: Try to pay more than the minimum amount due each month. This reduces your balance faster and means less debt for interest to build on.
  • Pay Off High-Interest Cards First: If you have more than one credit card, focus on paying off the one with the highest interest rate first. This card adds the most interest to your debt, so getting rid of this balance can save you money. This is called the Avalanche Method of repayment, and I’ll have more to say about it later on.
  • Make Payments More Often: Instead of waiting until the due date to make one big payment, try making smaller payments more frequently, such as every two weeks. This reduces your balance more often, which means there’s less balance for compounding.
  • Use Low-Interest or 0% APR Offers: If you can, transfer your balance to a card with a lower interest rate or a 0% APR promotional period. This can give you time to pay down your balance without interest adding up.

By using these strategies, you can manage your credit card debt better and avoid letting interest charges pile up too high.

Using Debt Repayment Strategies to Mitigate Interest

When you have unpaid balances on multiple credit cards, some may cost you more because of their higher interest rates or larger balances. You can use a couple of effective repayment strategies even if you don’t consolidate your debt through balance transfers or a personal loan.

With the Avalanche Method, you look at all of your credit card debts and see which one has the highest interest rate, not just the largest amount. Focus on paying off this card first because it’s adding the most interest to what you owe. This method can help you save money on interest over time.

Alternatively, you may prefer the Snowball Method. Start by paying off your smallest debt first and then move to the next smallest. This method may cost a bit more in the long run but can provide more motivation as you see debts disappearing faster.

Debt Snowball vs Avalanche methods graphic

Although the Avalanche Method often saves you money compared to the Snowball Method, your actual results depend on your circumstances.

Let’s compare examples of the two methods. 

Assume you have a portfolio of three credit cards, each with its own APR and unpaid balance. Further, assume you stop using all three and repay $500 per month for a year. At the start:

  • Card A has a 22% APR and a $5,000 balance
  • Card B has a 19% APR and a $7,000 balance 
  • Card C has a 15% APR and $3,000 balance

You apply the minimum payments to Cards B and C. You apply the remainder to Card A.

The minimum payment percentage used for this example is 2% of combined interest and principal.

Here are the results after one year of applying $500 monthly payments using either the Avalanche or Snowball Methods for this portfolio of three credit cards. Figures are rounded, and the interest rate calculation uses the bank-year convention.

Avalanche Method (focus on highest APR first):

MONTHINTERESTPAYMENTBALANCEINTERESTPAYMENTBALANCEINTERESTPAYMENTBALANCETOTAL BALANCETOTAL INTEREST
CARD A (22% APR)CARD B (19% APR)CARD C (15% APR)
191.67297.034,794.63110.83142.226,968.6237.5060.752,976.7514,740.00240.00
287.90298.144,584.39110.34141.586,937.3737.2160.282,953.6814,475.45235.45
384.05299.244,369.20109.84140.946,906.2736.9259.812,930.7914,206.26230.81
480.10300.344,148.96109.35140.316,875.3136.6359.352,908.0813,932.34226.09
576.06301.433,923.60108.86139.686,844.4836.3558.892,885.5413,653.62221.27
671.93302.513,693.02108.37139.066,813.8036.0758.432,863.1813,369.99216.37
767.71303.593,457.14107.89138.436,783.2535.7957.982,840.9913,081.37211.38
863.38304.663,215.86107.40137.816,752.8435.5157.532,818.9712,787.67206.29
958.96305.722,969.10106.92137.206,722.5635.2457.082,797.1212,488.78201.11
1054.43306.782,716.75106.44136.586,692.4234.9656.642,775.4412,184.62195.84
1149.81307.832,458.73105.96135.976,662.4234.6956.202,753.9311,875.08190.46
1245.08308.872,194.93105.49135.366,632.5534.4255.772,732.5911,560.07184.99
TOTAL831.083,636.141,297.691,665.14431.31698.722,560.07

Snowball Method (focus on the smallest balance first):

MONTHINTERESTPAYMENTBALANCEINTERESTPAYMENTBALANCEINTERESTPAYMENTBALANCETOTAL BALANCETOTAL INTEREST
CARD C (15% APR)CARD A (22% APR)CARD B (19% APR)
137.5255.952,781.5591.67101.834,989.83110.83142.226,968.6214,740.00240
234.77256.792,559.5291.48101.634,979.69110.34141.586,937.3714,476.59236.59
331.99257.642,333.8891.29101.424,969.56109.84140.946,906.2714,209.72233.13
429.17258.472,104.5891.11101.214,959.46109.35140.316,875.3113,939.35229.63
526.31259.311,871.5890.92101.014,949.37108.86139.686,844.4813,665.44226.09
623.39260.141,634.8390.74100.84,939.31108.37139.066,813.8013,387.94222.5
720.44260.971,394.3090.55100.64,929.27107.89138.436,783.2513,106.82218.87
817.43261.791,149.9490.37100.394,919.24107.4137.816,752.8412,822.02215.2
914.37262.62901.6990.19100.194,909.24106.92137.26,722.5612,533.50211.48
1011.27263.44649.539099.984,899.26106.44136.586,692.4212,241.21207.71
118.12264.25393.489.8299.784,889.30105.96135.976,662.4211,945.11203.9
124.92265.31133.0177.4199.334,867.38105.49135.366,632.5511,632.93187.82
TOTAL259.693,126.681,075.561,208.181,297.691,665.142,632.93

Summarizing the two methods after one year, we see that you experience a total interest of $2,632.93 for all cards in the Snowball Method. In the Avalanche Method, you incur less interest, a total of $2,560.07. At the end of the year, you still owe $11,632.93 using the Snowball Method. With the Avalanche Method, you owe $11,560.07. 

The Avalanche Method pays down Card A fastest by making minimum payments on Cards B and C. The Snowball Method nearly pays off Card C during the first year by making minimum payments on Cards A and B. 

The Avalanche Method is generally more effective than the Snowball Method in this example for several reasons:

  • Lower Total Interest: Over one year, the Avalanche Method results in less total interest paid compared to the Snowball Method. Specifically, you pay $2,560.07 in interest with the Avalanche Method versus $2,632.93 with the Snowball Method. This savings occurs because the Avalanche Method prioritizes paying off the debt with the highest interest rate first.
  • Quicker Reduction in High-Interest Debt: The Avalanche Method focuses on paying down the debt on Card A, which has the highest APR at 22%. By targeting this card first, you significantly reduce the amount of interest accruing at the highest rate, thus decreasing the overall interest you pay over time.
  • Efficiency in Reducing Total Debt: At the end of the year, the total remaining balance is lower with the Avalanche Method. You owe $11,560.07 with Avalanche versus $11,632.93 with the Snowball Method. This demonstrates that the Avalanche Method not only saves money in terms of interest but also effectively reduces the principal balance faster.

These points illustrate why, in scenarios where multiple debts have significantly different interest rates, the Avalanche Method is usually more efficient and cost-effective in managing and paying off debt.

However, the Snowball Method can work better in some situations, especially when it feels good to finish paying off some debts quickly. Here’s when the Snowball Method might be the best choice:

  • Small Debts: If you have several small debts, you can finish paying them off one by one. This can make you feel good and keep you motivated to keep going.
  • High Interest on Small Debts: If your smaller debts also have high interest, paying them off first makes sense. This can save you money on interest, similar to the Avalanche Method.
  • Simple to Manage: The Snowball Method can simplify things if handling lots of debts feels overwhelming. You just focus on the smallest debt, which can make managing your money feel easier.
  • Income Changes Often: If your income changes a lot, paying off small debts first can quickly reduce the amount you owe each month. This can give you more room to handle money better when your income goes up or down.
  • Feeling Good About Progress: Quickly paying off small debts can make you feel like you’re progressing faster. This can help you stay on track with your plan to pay off all your debts.

In these situations, the Snowball Method can be a good choice because it helps you stay motivated by giving you small wins along the way.

So, the Avalanche Method can be a great way to manage debts if you’re trying to minimize how much extra money you spend because of interest, especially when your high-interest debts are also the ones with the highest balances. 

You should model both methods to see which one suits you better. Moreover, it would be best to run the model for the entire time it takes to eliminate all your credit card debt — that’s the only way to see the final relative costs and speed of each alternative.

Regardless of which method you choose, always try to pay more than the minimum amount due on at least one of your credit cards. It may take a very long time to get out of debt if you only pay the minimum.

Interest Rates and Your Rights

When you use credit cards, the issuers let you borrow money to buy things or get cash. But they don’t do this for free; they charge interest and fees. It’s important to know about interest rates because they affect how much money you end up owing. Also, it’s good to understand your rights so you can be smart about using credit cards.

Federal Regulations

Some important laws help protect you when you use credit cards. These laws ensure that credit card companies are clear about how much they charge and that they treat you fairly.

The Truth in Lending Act (TILA) ensures credit card companies tell you upfront about the interest rates they will charge and any other fees. It requires them to be clear about all the costs of using their credit cards.

The Credit Card Accountability Responsibility and Disclosure Act (CARD Act) of 2009 provides additional protections. For example, it says credit card companies can only raise your interest rates in the first year after account opening if certain conditions apply. 

Those conditions include whether you agreed to an introductory rate that ends, you’re late on a payment for 60 days, or the rate changes because it’s tied to an index. It also requires companies to tell you 45 days in advance if they plan to raise your rates.

These laws help you know what you are getting into when you sign up for a credit card. They can help you avoid surprises by requiring companies to explain all the fees and rates clearly.

They also ensure that if a company wants to change anything about what you pay in interest, it has to tell you ahead of time. This gives you a chance to decide whether to keep using the card at the new rates, pay the card off and not use it, or pay it off and close your account.

Understanding these laws can help you make better choices about using credit cards and protect you from unfair practices.

Read the Fine Print

When you get a credit card, you receive a printed or digital document called a cardholder agreement. This is very important because it tells you the rules about using your credit card, including how and when you need to pay back the money you borrow.

Importance of the Cardholder Agreement

The cardholder agreement is your credit card’s rule book. It explains everything from the fees it can charge to the penalty for missing a payment. 

Citi credit card agreement screenshot
Card issuers typically make card agreements easy to access on their websites.

Carefully reading the agreement helps you understand what you can and can’t do with your card. It also should prevent surprise fees or big interest charges.

Specific Clauses Regarding Interest Rates

Cardmember agreements may run dozens of pages, so it’s helpful to know which parts are the most critical for you to read. If you look at nothing else, at least take the time to read the following sections:

  • Interest Rate Details: Look at your interest rates. This is how much extra you have to pay for the money you borrow. Check if your rate can change and what could cause that change.
  • Introductory Rates: Sometimes, cards offer a low interest rate for the first few months (this is called an introductory rate). Make sure you know when that rate ends and what the new rate will be.
  • Grace Period Clause: This part tells you the set number of days you have to pay for your purchases without incurring any interest. Not all cards have a Grace Period, and if they do, it only applies if you pay your entire balance each month. Pay attention to how long the period is and what you need to do to avoid paying extra interest. Grace Periods usually run 21 to 28 days, from the statement closing date to the payment due date.
  • Late Payment Penalties: Find out how much your interest rate could go up if you miss a payment. Some cards have a penalty rate that is much higher than the normal rate. Most cards charge a late fee, which can be as high as $41.
  • Changes to Interest Rate: Look for information about how and when the credit card company can change your interest rate. It should include how the issuer will inform you if your rate is going up.

Reading these parts of your agreement can help you avoid unexpected costs and manage your credit card better. Always know what you agree to because that can save you a lot of trouble and money.

Understand the Impact of Credit Card Interest Rates

Your credit card interest rates can impact your budget, the amount of debt you carry, and even your lifestyle. When a credit card has a high interest rate, you may pay a lot more than you borrowed. This can eat up a big part of your budget each month, especially if you’re only making the minimum payments. 

Over time, this means you’ll have less money for other things you need or want, and it could take a lot longer to get out of debt. Choosing a credit card with a lower interest rate can help you keep your debt manageable and leave more of your money for other pursuits.