How to Calculate Your Credit Card Interest?

Tuesday, January 20th, 2015

Understanding how credit card interest is calculated is important if you want to be more educated and use your credit card more effectively. Here we’ll explain how most credit card issuers calculate your interest payments and how your individual rate is determined.

For a start, let’s remember some basics about credit card interest:  if you pay off the entire card balance each month, then you will not pay any interest. However, it is reasonable to be aware of your interest rates and whether those rates are fixed or variable. Variable interest rates change and banks should notify cardholders before raising rates. Interest rate is also known as an annual percentage rate (APR) and for most people falls between 12.99% and 29.99%. The majority of credit card companies use a daily interest rate and an average daily balance method to calculate interest charges. This means that your interest is compounded based on your daily balance.

Now we figure out how much interest you actually owe. As an example, let’s say your last statement balance was $1,000, and your APR is 22%.

1.       Calculate your periodic interest rate

As you already know, you don’t get charged interest on your balance once a year. Actually, your interest compounds daily. This means that a little bit of interest is added every day your balance is unpaid. To find out your daily rate divide your APR by 365. In our example, that’s 0.06%. This is the periodic interest rate (or daily periodic rate) which compounds every day.

2.         Determine your average daily balance

The amount of interest owed increases with every day you don’t pay your balance. However, it is worth paying off some of your balance early because a bank will look at your average daily balance. For example, you don’t pay off your above mentioned $1,000 for the first 10 days that it accrues interest. On day 11, you pay off $600. Your average daily balance is (10x$1,000 + 20x$600)/30 = $733. So, the longer you wait to pay off your balance, the more interest you’ll accrue.

3.       Calculate interest charge

Now you only need to multiply your average daily balance by your periodic interest rate, and multiply that by the number of days in the month to figure out your interest charge for the next month: $733 x 0.06% x 30 = $13.2.

Keep in mind that your interest is charged from the date of purchase, not from the beginning of the next month. There is no grace period unless you pay off your card balance in full by the end of the period, in which case the interest charges are waived.

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