What is Accrued Interest? How Credit Card Interest Adds Up Over Time

Definitions of accrued interest tend to be complicated – so much so that I’m dismayed because the concept is simple and should be easy to understand.

Accrued interest is interest a borrower owes a lender, but hasn’t yet paid.

With credit cards, the borrower is the person who uses the card. The lender is the card company. With investments, the borrower is the corporation, government agency, or other entity that issued the debt. The lender is the investor.

As both a card user and investor, I have experience with both types of accrued interest — the type I try not to pay with my cards and the type I try to earn with my investments. 

The more experience you gain with your credit cards, the more familiar you’ll be with the concept of accrued interest and the amounts you have to pay. So let’s cut through all the jargon together and dive right into the details of how accrued interest impacts you.

Accrued interest generally works the same way for both credit cards and investments. The only difference is that one may cost you money, while the other can make money for you. 

The Basics of Accumulating Interest

Whenever you use your card to buy something, you’re borrowing the purchase price from your card company. Your unpaid balance is a debt that you owe, and as such, it usually involves interest payments.

Interest is a charge that borrowers pay to borrow money from lenders. Unlike a flat fee, interest is based on a period of time and a percentage. The time period is often expressed as an annual percentage rate (APR).

Most credit cards have a monthly grace period during which you don’t have to pay accrued interest if you pay your balance in full on or before the due date. The grace period typically starts the day your statement is prepared and continues until the day your payment is due — usually about 21 days. 

If you don’t pay your balance in full during the grace period, your unpaid debt will carry over to the next period and the accrued interest will be added to your balance. 

Once this happens, you lose your grace period until the entire balance is paid. To avoid new interest charges, you’ll have to pay the balance and accrued interest that you carried over, plus any amounts for new purchases and the accrued interest for those purchases.

Think about that for a minute and you’ll see why the grace period is so valuable and why it’s smart to pay your balance in full every month during this period. 

You’ll also see why it’s so easy to dig yourself into a financial hole if you don’t. I’ve never forgotten how shocked I was at how much interest I owed the first time I carried a balance on a card from one month to the next. For me, that first time — for a major car repair — was also the last.

Flip this scenario around and you’ll see the advantage of being an investor instead of a borrower.

As an investor, you have an opportunity to earn interest instead of paying it.

There’s one caveat: investments aren’t risk-free. You could lose money as market interest rates and the values of your investments fluctuate over time.

Daily vs. Monthly Accrual Rates

Even though interest rates are often expressed as APRs, the time period used to calculate interest may be as short as one day or one month. Interest also may be calculated quarterly (three months), semiannually (six months), or in other time periods.

Interest that accrues daily is calculated and charged every day.

Interest that accrues monthly is calculated and charged once each month, usually on the same day of the month, such as the 15th or 30th. 

Months that have 28, 29, or 31 calendar days are often treated as if they have 30 days for purposes of interest calculations. 

Similarly, years may be treated as if they have 360 days instead of 365 or 366. That may sound strange, but it’s actually an attempt by the banking industry to make things simpler.

Accrued Interest on Your Statements

If you’re curious about how accrued interest is calculated, you could try to do the calculations yourself using your APR, your average daily balance, the number of days in your billing period, and a piece of paper and a well-sharpened pencil.

Fortunately, there’s an easier way, which is to use an online interest calculator. Results from different online calculators may vary slightly, but, generally, the discrepancies aren’t material.

Your monthly credit card statements include a wealth of information, such as your APR, your average daily balance, and the total amount of interest you owe.

An even better use of your time would be to study your card statements for the last three, six, or 12 months. These documents provide a wealth of information, including your APR, your average daily balance, the total amount of interest you’ve been charged each month, and how long it will take to pay off your balance if you make only the minimum payments.

If you always pay your balance in full, you’ll never have to worry about your APRs, your accrued interest, or how many days your card company uses for its calculations. I have no idea what my APR is for any of my cards. Because I don’t carry a balance, this information isn’t relevant to me.

The most important thing you should know about accrued interest is that if you make only the minimum payment every month, your card balance will usually go up rather than down even if you don’t make any more purchases with your card.

Minimum Payments Mean Growing Interest Charges

With most cards, the minimum payment covers only a portion of the accrued interest, and that portion could be relatively small.

The unpaid accrued interest gets added to your balance every month. And when you continue to make minimum payments, your balance (and the amount of interest you pay) continues to grow. 

Not only will that lead to you paying more over time, it also increases the minimum payment. So, then you are paying even more to not chip away at your balance. You will also lose your interest-free grace period — if your credit card has one.

The Long-Term Impact of Compounding Interest

Those excess amounts may seem like a small matter, but in practice, they can have a big impact because over time the accrued interest is compounded. This means it not only adds up, but also results in even more accrued interest.

That happens because your APR isn’t just applied to your purchases. It’s applied to your whole balance, which includes your accrued interest. Every time you make only the minimum payment, you’re borrowing the shortfall, and then you’re being charged interest on the interest. 

With investments, you can earn interest, so compounding can be a huge benefit. When you pay interest on your cards, it has the opposite effect and can make paying off your card balance harder.

How to Avoid Interest Accrual

The only way to avoid the negative effects of compounding credit card interest is to make payments that are significantly more than your minimum.

Even if you pay just a little more than your minimum payment, you’re compounding that extra money to combat future interest charges. 

If you can’t pay your credit card balance in full, pay as much as you can above the minimum payment. This could help you save months or years of additional interest charges on your debt.

Depending on your balance, paying more than the minimum could help you resolve your credit card debt months or years earlier. And, you will likely save a lot of money over that time. 

Other strategies that could help include paying off high-interest balances first, using balance transfers, setting up automatic payments, and making biweekly payments.

Pay Off High-Interest Balances First

Paying as much as you can toward your highest APR balance can free up more cash faster to pay off your lower APR balances. 

The goal is to try to get ahead of the accumulating interest charges. Be sure to also make at least the minimum payment for every card on which you have a balance so you won’t get hit with late payment charges.

This strategy is more commonly called the Debt Avalanche, and it is one of the only times paying the minimum on some cards can actually help you tackle debt in the long run.

The Debt Snowball method is a similar strategy, but instead of focusing on your highest APR balances, you focus on your smallest overall balances first — regardless of APR. This can give you some short-term debt-clearing wins and keep you motivated to tackle your higher balances over time.

Balance Transfers to Temporarily Reduce Interest

Transferring a balance from a card with a higher APR to a card with a lower or 0% APR can also help you avoid accrued interest.

Balance transfer credit card promotions can run from six to 18 months or more depending on the card, so choose wisely.

Be sure to read the disclosures and do the math before you transfer a balance because the fees can be high and will reduce the benefit of the lower or 0% APR.

This type of debt reduction strategy only works if you pay off the entire transferred balance before the offer ends. Once the promotional period is over, the card will revert to its regular APR and charge that on the entire balance that is left.

If you don’t pay it all, you might end up right back where you started.

Set Up Autopay for Timely Payments

Setting up autopay for your cards can help you make payments on time, avoid late payment fees, limit accrued interest, and even boost your credit score. 

Be careful, however, not to “set it and forget it.” Even if you use autopay, you should review your account statements every month and make sure you pay more than the minimums to pay off any debt you’re carrying over in a timely manner.

One more good strategy is to make biweekly payments. Making payments every other week instead of once each month can dramatically reduce how much interest accrues on your card.

If you have a significant amount of debt, making biweekly payments can be worth the extra time, effort, and recordkeeping.

Now that you understand the concept of accrued interest, you may feel much more in control and ready to manage — and pay off — your credit card debt. 

While the process can take time, making consistent payments that are significantly more than the minimum due should make a dent in your debt and get you closer to being debt-free.