How credit card interest works, and why minimum payments take so long

Credit cards are one of the most expensive ways to borrow money, but because there's no fixed payoff date, the true cost of carrying a balance is easy to underestimate. Here's how card interest is calculated, why minimum payments take so long, and what actually speeds up payoff.

APR and the daily rate

Your card's annual percentage rate (APR) is the yearly interest rate. Most card issuers in the US don't charge that once a year. Instead they divide it by 365 to get a daily periodic rate, and apply it to your balance each day. At a 22% APR, the daily rate is about 0.06%.

Interest is usually calculated on your average daily balance over the billing cycle, then added to the balance. That means interest itself starts earning interest in the following months.

The grace period

If you pay your full statement balance by the due date every month, most cards charge no interest on purchases at all. This is the grace period. Once you carry a balance from one month to the next, you typically lose it, and new purchases start accruing interest immediately until the balance is paid off in full again. Cash advances usually have no grace period and often a higher APR.

Why minimum payments take so long

Minimum payments are designed to be small. A common formula is 1% of the balance plus that month's interest, with a floor of something like $25. As the balance falls, the minimum falls too, so the payoff keeps slowing down.

Consider a $5,000 balance at 22% APR. The first month's interest alone is about $92. Paying only a minimum calculated as 1% of the balance plus interest (with a $25 floor), it would take about 19 years to pay off, and you'd pay roughly $8,100 in interest, more than the original balance.

What a fixed payment does

Now pay a fixed amount each month instead:

• $200 a month: paid off in about 34 months, with about $1,750 in interest.
• $300 a month: paid off in about 21 months, with about $1,022 in interest.

The difference comes from a simple fact: every dollar above the monthly interest goes straight to the balance. A fixed payment keeps that extra amount from shrinking over time the way a minimum payment does.

Strategies for multiple cards

• Avalanche: make minimum payments on every card and put all extra money toward the card with the highest APR. This saves the most interest.
• Snowball: put extra money toward the smallest balance first. It costs a bit more in interest, but paying off a card quickly can help keep you motivated.
• Balance transfer: move a balance to a card with a 0% introductory rate. This can save a lot if you pay the balance off before the promotion ends, but expect a transfer fee of a few percent and a normal APR afterward.
• Consolidation loan: a personal loan at a lower fixed rate turns card debt into a fixed payment with a definite end date, as long as you don't run the cards back up.

Stop the balance from growing

None of these strategies work if new charges keep adding to the balance. While paying down a card, it helps to use a debit card or cash for everyday spending, and to set up automatic payments so a missed due date doesn't add late fees or a penalty APR.

Plan your payoff

The credit card payoff calculator shows how long your payment will take and how much interest you'll pay, or the payment needed to clear the balance by a target date. For fixed-rate debts like personal loans, use the loan calculator.