Understanding credit card interest

Before you start using your new credit card, it’s important to understand how credit card interest works. We’ve collected the top tips to help you avoid extra charges while making the most of your credit card rewards.

When it comes to paying for your day-to-day expenses, a credit card is a safe and convenient option. Using credit is an easy way to pay for everything from your streaming subscriptions to that trip to Rome. 

But before you start charging everything to your card, there’s one important thing you need to know — what is credit card interest and how does it work?

Having a basic understanding of credit card interest can help you maximize the benefits of your card and avoid racking up extra charges. This guide breaks down all the basics, from how interest is calculated to finding a low-interest card, so you can be smart and savvy with your credit card.

How does credit card interest work?

Credit card interest is the amount your card issuer charges you if you don’t pay your card balance in full by the due date. You’ll keep paying a percentage of your outstanding balance in interest until you’ve paid off your balance entirely.¹

Now let’s dig deeper into credit card interest:

• First, here’s how credit cards work: When you buy something with a credit card, you’re basically borrowing money from a credit card issuer (like BMO) , and you’ll start building up a balance, which is the amount you’ll owe back at the end of the billing cycle.
• What to know about your billing cycle: Your billing cycle is the period of time between billings, usually somewhere between 27 and 31 days. At the end of your billing cycle, you need to pay off your balance, or you’ll be charged interest on the amount you owe.
  
• Paying off your credit card: You can pay off your balance in full, or just a portion of it. The lowest amount you can pay each month is called your minimum payment, which you can find on your credit card statement. If you pay everything you owe by the due date, you won’t be charged interest on your purchases.²

But if you only pay a portion, the remaining balance carries over to your next billing cycle, and you’ll accrue daily interest on the amount you owe. This means you’ll have to pay interest on your purchases from the day you make them till the day you pay them off.

Let’s say you have a $1,000 balance on your card, and your payment is due by January 31st. If you pay off the $1,000 by that date, you won’t be charged any interest. For the next 21 days (also known as your grace period), any new purchases you make with your card will be interest-free. If you don’t pay off your balance in full, your grace period will increase to at least 25 days on your next credit card statement, but you’ll be charged a daily interest on $1,000 from the date of each purchase until the day you make a payment towards your credit card.

If you pay off $1,000 by the due date, your grace period will go back to 21 days on your next statement. If you only pay $500, you’ll lose your grace period and will be charged daily interest on the remaining $500, plus any purchases you make during the next billing cycle.

Here's another example that shows what your interest charges could look like, if you don’t pay your balance off in full.

Let’s say you accumulate a balance on your card of $3,000, and your APR is 12.99%. If you pay $200 per month toward your balance, you’ll wind up paying around $291.58 in interest over the span of 17 months before your balance is paid off in full. 

What’s my interest rate?

Your credit card issuer is required to tell you your interest rate – or  APR A P R – before you apply for a credit card.

Your APR is the yearly rate you’ll be charged if you carry a balance. And though it’s called an “annual percentage rate,” your credit card company will use that rate to calculate the interest you owe on your monthly statements.

Your card may have different interest rates for different purposes. For instance, the interest rate might be 19.99% for purchases, but 22.99% for cash advances on the same card. So, make sure you know how you’ll use the card before applying.

How can I avoid interest charges?

One benefit of credit cards is being able to pay back purchases in portions, like taking a few months to pay off the balance you accumulated from buying a new couch. In that case, interest is unavoidable. But there are a few ways to avoid unnecessary or excessive interest charges:

1. Pay as much as you can each month 

The best way to avoid interest charges is by paying off your entire balance by the due date and avoiding cash advances if possible. You won’t be charged any interest on purchases you’ve made, and you can still enjoy the benefits of your card (like these sweet reward offerings, secure online payments, etc.).

However, it isn’t always easy (or possible) to pay your entire balance every month. Just make sure to always pay at least the minimum payment, if not more. The more you pay, the less you’ll owe and the less interest you’ll get charged. 

2. Make sure to pay on time

Always make a payment before your due date. Even paying a day or two late can mean getting hit with interest charges. Banks might even raise your interest rate if you miss too many payments. Missing or late payments can also negatively impact your credit score.

The best way to never miss a payment? Set up automatic payments online. You can choose to pay your balance in full or the minimum balance owing automatically on a certain day each month. That way you never have to worry about missing a payment.

Tip: Credit card payments are processed during business days, and depending on your method of payment, they could take a few days to process. So, if your payment is due on a weekend or holiday, be sure to pay it off either before or no more than 1 business day after to avoid being charged any late fees.

3. Get a low interest credit card

If you regularly carry a balance into your next statement cycle, you might want to get a low-interest credit card to minimize the interest charges you’ll pay each month. Low interest credit cards are typically no-frills cards without a rewards program, and their interest rates tend to be well below the average 19.99% rate. The BMO^® Preferred Rate Mastercard^®, for example, offers an interest rate of 12.99% for purchases.

Credit cards come with a ton of perks and a lot of responsibility. It’s important to understand how credit card interest works so you can keep your credit score, debt and finances in check. One key thing to remember: Interest is charged based on the amount you owe, so making regular, on-time payments is the best way to maximize your card benefits and keep interest charges under control.