Credit card interest occurs when a user fails to pay in full for their card's monthly balance. The amount you pay on top of every dollar not yet paid is considered the "interest rate" on a card. This amount must be indicated in the conditions of the card application so that you have the information available.
To calculate the dollar amount you will be paying in interest for a given month (which we will discuss in more detail below):
Find your average daily rate
Find your average daily balance
Multiply your answers from step 1 and step 2
Take that number and multiply it by the number of days in the billing cycle
Follow the instructions below for a detailed look at how credit card rates work.
What are credit card rates?
Credit card interest is the amount you pay if a balance is not paid by the due date. This is how credit card companies make money. Think of this as the "subscription fee" to borrow your money.
Some cards have high interest rates and some have low interest rates. Typically, the lower your credit rating, the higher the interest rate. You should be careful about using cards with high interest rates as this can quickly lead to large debts if the funds are not paid back on time. If so, this is what you should consider Cancellation of your credit card.
How is credit card interest calculated?
There are two key elements to consider when determining the interest rate on your card: the average daily rate and the average daily balance. When multiplied, you get the interest payment for the specified period, which is the extra dollar amount you owe if you don't pay it off in full.
Here you get a detailed overview of the calculation of the monthly interest payment on your credit card. We'll also go through a sample calculation that you can easily apply to your personal finances.
1. Calculate your average daily rate
First of all, you need to calculate the amount of interest that you will pay every day throughout the year. Just divide the annual interest rate (this is usually the percentage a card company gives you on the contract) by 365.
Example: For a yearly Interest rate of 15%
Take 0.15 (annual interest rate) and divide it by 365 (total number of days in the year).
.15 / 365 = .00041096
Average daily rate = .00041096
Make a note of this amount for easy use.
2. Calculate your average daily credit
To calculate your average daily balance, you'll need your latest credit card statement. Next, do the following:
Write down your final balance day by day
Add up each day's balance
Divide the total by the number of days in the current billing cycle
Add up each day's balance
Day 1 Final Balance: $ 100
+ Final balance for day 2: USD 105 …
+ Day 30 Final Balance: $ 1,000
= $ 6,100
Divide by the total number of days in the billing cycle
$ 6,100 / 30 days = $ 203.33
Average Daily Balance = $ 203.33
3. Multiply the average daily rate by the average daily credit
This step is easy. Multiply your answer from step one and step two.
Average daily rate (from step 1): .00041096
Average Daily Balance (from Step 2): $ 203.33
.00041096 x $ 203.33 = 0.084
4. Calculate the interest owed this cycle
To find the interest payment for a particular billing cycle, multiply your answer from step three by the number of days in the billing cycle (this is the same number you used in step 2 to find your average daily account balance).
Answer from step 3: .084
Number of days in the billing cycle: 30
0.084 x 30 = 2.52
Interest payable for this billing cycle = $ 2.52 *
* Note: this amount is put together every day if the balance is not paid in full.
Interest rate vs. APR
When it comes to credit cards, interest rates and APR are those equal. For other loans, the interest rate determines the cost of borrowing the amount you requested. The annual interest rate is an annualized interest rate that includes certain fees as "financing costs". APR is designed to allow consumers to compare the shop based on the actual cost of borrowing and give a more accurate idea of what to expect.
How to find your credit card interest rate
Please refer to your contract or application for information on the annual interest rate on your card. Keep in mind that it may be listed as an APR as the two are interchangeable when it comes to credit cards.
The amount is expressed as a percentage. This is the amount you will pay in addition to any remaining balance if you do not pay off the full amount.
3 Ways To Avoid Paying Credit Card Interest
There are some strategies that you can use to avoid paying high interest on your credit card payments and, in some cases, avoid paying interest at all.
It is important to understand these tactics to avoid creating uncontrollable credit card debt. Remember, balances carry over from month to month and can get exponential in a short period of time.
Full wage balance
The best way to avoid credit card interest is to pay off your balance in full at the end of each billing cycle. Since the interest is based on remaining balances without one, there is nothing to calculate (imagine multiplying by zero).
Never spend too much
Only charge what you can realistically withdraw from your credit card at the end of each cycle. Even the absence of a payment can create a ripple effect of high interest payments across the board. Stick to a budget and know what you can afford, especially when dealing with credit cards.
Use your card for necessities
Use the credit card only for certain purposes (e.g. Food). That money has to be spent regardless, which makes it much easier to avoid interest by paying out the balance at the end of the cycle. This practice also promotes a healthy credit score.
A thorough understanding of your contract with a credit card company is the best place to start to understand how credit card rates work. Often times it's a single process, but each company will have its own terms and conditions. Understanding the basics above can help you make more informed decisions about which Credit cards are best for you.