How credit card interest is calculated

Find out how to decipher confusing credit card interest rates
Acronyms: know your EAR from your APR
Helping you to decide which credit card is really the right one for you

Unfortunately you can't choose a credit card just by comparing interest rates.

Credit card issuers now use 14 different methods of charging interest. If you pay your bill in full, this usually won't affect you. But if you take cash out of a cash machine with your credit card, or pay anything less than the full amount on your statement, you'll normally be charged interest.

In fact, if you had two cards with the same interest rate and used them in exactly the same way, one could end up costing over twice as much as the other just because it calculated your interest differently.

This is because the amount you are charged depends not just on the card's rate but on when it starts and stops charging interest.

Our Best Rates take this interest rate disparity into account and should help you find the right card for you.

Don't rely on headline rates

It all boils down to the acronyms; the annual percentage rate, known as the APR, and the effective annual rate, known as the EAR, as well as your credit card issuer's attitude to risk.

While both APR and EAR place the emphasis on an annual calculation of interest, they do not necessarily mean that interest is totted up at the end of each year. Instead most cards will compound interest on a monthly basis.

In theory, cards with lower APRs should be cheaper, however in practice there are a number of problems with APRs on credit cards.

While APR is a standard way to calculate the cost of credit that takes account of the interest rate and other charges, two cards with the same APR can charge very different amounts of interest. The reason for this is that card providers start and stop charging interest on transactions at different times.

Risk-based pricing

It's increasingly common for banks and credit card companies to use a customer's credit history to set interest rates on their credit card.

For some cards, the rate of interest on purchases or cash withdrawals will be much higher than on a standard balance transfer

People with a poor credit history are generally offered a higher rate. In principle, risk-based pricing is a fair way for those with good credit histories to get cheaper rates. But how banks decide their rates isn't clear, so it's hard to compare.

Unlike some financial products it's easy to switch credit cards, but millions of us still pay high rates of interest and even annual fees.

Additional interest

If you've borrowed money on your card, and then repay the next bill in full, some companies, such as HSBC, charge interest only up to the date they produced the bill.

However, most companies, including American Express, Cahoot, Halifax/Bank of Scotland and RBS/NatWest, charge interest right up to the point they receive payment from you.

So on your following month's statement you are charged interest from the date of your last statement up to the point you paid the bill (see the table, below). The crazy bit is that there's no way to work out how much it will be.

How some cards charge additional interest

Credit card companies that charge in this way say that, to stop being charged interest, you can pay more than the amount you owe on your bill. However, you don't know how much more to pay so you could end up in credit.

Interest on interest

Another complicating factor is that most cards charge interest on interest accrued in previous months. However, Egg, Tesco and Ulster Bank don't do this.

Charging from the date of purchase

Most credit cards charge interest from the date you buy something, while others, including HFC, HSBC, Liverpool Victoria, M&S and Saga, are fairer and wait until a few days later, when the credit card company actually pays the retailer for your purchase.

Unless you really need to, try not to withdraw cash using your credit card - the interest rates are eye-wateringly high

No interest-free period

If you owe money from a previous month, some cards, such as M&S, Sainsbury's and Tesco, scrap your interest-free period on new purchases — even if you pay the next bill in full.

For more information on different credit cards and their pros and cons, have a look at our Best Rates or see our guide to choosing a credit card.

Different transactions attract different interest rates. Unless you pay off the balance in full each month, you're charged interest on the value of purchases made with the card. The rate of interest you pay is the 'purchase rate'.

To take cash out, normally a higher rate of interest (the 'cash withdrawal rate') is charged, and you'll usually be charged from the day you make the withdrawal, even if you pay off the balance in full.

Most cards offer a reduced introductory rate (the 'transfer rate') for a debt transferred to the card from elsewhere.

Incentives like this only usually apply to the transferred balances, although some cards give reduced rates for new purchases as well.

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