Credit card interest explained: APR, minimum payments and persistent debt

The short answer: credit card interest is your APR applied to what you owe, charged each month. At 24.9%, a £3,000 balance costs about £62 in the first month. Pay the whole statement balance by the due date and you pay nothing on purchases. Pay less and interest builds up. The minimum payment is designed to keep you in debt: on a 24.9% card, paying only the minimum can take 13 yrs 5 mo to 28 yrs 9 mo to clear £3,000.

How interest is charged

• APR to monthly. Divide the APR by 12 for a rough monthly rate: 24.9% is about 2.07% a month. Real cards work daily, so your statement will differ by a few pounds.
• The interest-free period. If you paid the previous statement in full, new purchases are normally interest-free until the due date, often up to around 56 days. It varies by card.
• Carrying a balance cancels it. Once you leave any of the statement balance unpaid, new purchases usually start charging interest from the day you make them.
• Cash withdrawals. These usually cost interest from day one, with a fee on top, commonly around 3% to 5%.
• Interest on interest. The unpaid interest joins your balance, so next month’s interest is charged on a slightly larger sum.

How the minimum payment works

UK rules say the minimum has to cover the month’s interest, fees and charges plus at least 1% of the balance. Cards choose how to do it, and the two most common recipes give very different results on the same £3,000 at 24.9%:

With the 1% recipe, the minimum falls as the balance falls, so the payments shrink and the debt drags on for decades. The fix is the same for any card: set a direct debit for a fixed amount, not the minimum. Your own card’s terms will say how its minimum is worked out.

Persistent debt: the letter nobody wants

You’re in persistent debt if, over the last 18 months, you’ve paid more in interest and charges than you’ve repaid of what you borrowed. Your card provider has to write to you, and what follows is set by the regulator:

• At 18 months your provider tells you, and explains how paying more would cut the cost.
• At about 27 months it reminds you if you’re likely to still be in persistent debt at 36 months.
• At 36 months it must offer a way to clear the balance in a reasonable time, often around three to four years, which can include reduced interest or fees. As a last resort, it can suspend the card.

How the minimum is built makes a big difference. Under the 1% recipe, you repay principal at just 1% of the balance each month, while the interest at 24.9% is about 2.07% of it. Over the first 18 months on £3,000 that works out like this:

The rule of thumb that falls out of this: if your card’s minimum is 1% plus interest, anything above a 12% APR puts you in persistent debt if you only pay the minimum. With a 2.5% recipe it takes an APR above 30%. Paying a fixed amount above the minimum gets you out of the category and out of debt far sooner.

A letter is a prompt, not a punishment. You can respond by raising your payment, or if you can’t afford more, by calling your provider and asking for help. StepChange, National Debtline and Citizens Advice give free advice.

What to do next

Work out how long your balance will really take with the credit card calculator. For a larger balance, see how long £5,000 takes. If the rate is the problem, a balance transfer may help, and with several debts, which to pay off first covers the order.

This is general information, not financial advice. Examples use APR divided by 12 and common minimum payment recipes. Your own card’s terms will differ.