How credit card interest and minimum payments work

Interest is calculated daily, not monthly

Your card has an APR — an annual percentage rate. But card issuers generally do not charge you once a year, or even once a month. They break the APR into a daily periodic rate by dividing it by 365, then apply that rate to your balance every single day of the billing cycle.

Most issuers use the average daily balance method. They take your balance at the end of each day of the cycle, average those numbers, and apply the daily rate across the days in the cycle. This is why a payment made early in the cycle reduces interest more than the same payment made on the last day — it lowers the balance for more days.

Because yesterday's interest becomes part of today's balance, interest can compound. On a card carrying a balance month to month, you are paying interest on interest.

The grace period, and when you lose it

If you pay your statement balance in full by the due date, most cards give you a grace period on new purchases — meaning no interest is charged on them. Carry a balance instead, and that grace period typically disappears until you pay in full again. New purchases can then start accruing interest immediately, from the day they post.

Cash advances usually have no grace period at all, and often carry a higher APR plus a separate transaction fee.

How the minimum payment is set

The minimum payment is not a recommendation. It is the smallest amount that keeps your account current, and it is calculated by a formula in your cardholder agreement. Common versions look like:

• A flat floor — often around $25 to $35 — or the full balance if it is smaller.
• A small percentage of the balance, commonly 1% to 3%.
• Or 1% of the balance plus that period's interest and any fees.

Whichever produces the larger number is what you owe. Your exact formula is in your agreement, and it is worth looking up.

Why minimums stretch a balance out

Here is the arithmetic that surprises people. Take a $5,000 balance at a 24% APR. That is roughly $100 in interest in a month. If your minimum is 2% of the balance, the minimum is also about $100 — so nearly the entire payment goes to interest, and the balance barely moves.

Under the "1% plus interest" formula, the minimum would be about $150: $100 of interest and $50 toward principal. The balance does fall — but slowly, and the minimum shrinks as the balance shrinks, which stretches the tail out for years.

None of this is hidden. It is just rarely explained.

Read the box on your own statement

Since the CARD Act of 2009, monthly statements must include a minimum payment warning. It shows how long it would take to pay off your current balance making only minimum payments, the total you would pay, and what monthly payment would clear the balance in three years instead. It is usually near the bottom of page one.

That box is the single most useful thing on the statement. Find yours and read it. It is your numbers, not an average.

What to look for

• Your APR — and whether you have more than one (purchases, cash advances, promotional rates).
• Whether a promotional rate has an expiration date.
• The interest charged this period, listed separately from your payment.
• The minimum payment warning box.

You do not need to be a numbers person to read these. You just need someone to point at them once.