Paying interest on your credit card balance is painful enough. Figuring out how to calculate credit card interest? That’s almost as bad! The entire process is rife with complexity — and not always set in stone.
Still, if you’re carrying a balance on a credit card, you should know the science behind how much interest you’ll ultimately pay. This post aims to answer the question: “How is credit card interest calculated, anyway?”
Calculating Credit Card Interest
When you’re carrying a balance on your credit card, you probably focus most of your attention on your card’s APR, or annual percentage rate. While that’s a decent way to figure out about how much interest you’ll pay over time, it’s not the most accurate.
Why? Because credit cards don’t add interest to your account annually as the name suggests – they actually charge interest every day.
This daily interest calculation uses your cards DPR, or daily periodic rate. You can figure out your DPR by taking your APR and dividing it by the number of days in the year. (One caveat, though: Some banks divide by 365, while others divide by 360. Confused yet? We thought so.)
How to Calculate Credit Card Interest in 3 Steps
Step #1: Divide APR by the number of days in a year to determine your daily periodic rate.
Step #2: Determine your average daily balance. Write down each day’s balance, starting with any unpaid balance carried over from the previous month. Once that is done, add it up and then divide by the number of days in the billing cycle.
Step #3: Multiply the average daily balance by the daily periodic rate.
Step #4: Multiply the result by the number of days in your billing cycle (30 days).
Bust Out the Calculator and Try These Examples
Know that you know the steps, let’s work through an example. We will say your credit card’s APR is 11%. Divide that number by 365, and you’ll discover that your daily periodic rate is 0.03%.
Here’s where things get even trickier. When credit card issuers charge interest using your DPR, they figure how much you owe using your average daily balance. This is because your credit card balance can fluctuate throughout the month as you make partial payments or buy more stuff.
So, here’s another example to illustrate how it all works together:
Let’s say you owe $500 on your credit card at the beginning of the month. Fifteen days after the new billing period begins, you charge another $500 on your card. Your card issuer determines your average daily balance for the month by multiplying each balance by the number of days you carried it, then combining them and dividing by the total number of days in the month:
($500 * 15 days) + ($1,000 * 15 days) = $22,500/30 days = $750 average daily balance
Using the daily periodic rate above, you’ll be charged $6.75 in credit card interest that month:
$750 * 0.0003 * 30 days = $6.75
How Is My APR Decided in the First Place?
No one wants to pay a lot of credit card interest, so it’s always in your best interest to choose a card with a low APR. The good news is, there are a wealth of credit card offers with low APRs, or even promotional 0% APRs, on the market. The bad news is, you may not always be able to qualify for them – at least not yet.
That’s because card issuers use your personal information and credit history to determine what type of interest rate they’ll charge you.
For example, those with good and excellent credit who have credit scores above 700 will generally qualify for cards with the most attractive rates. Meanwhile, those with average or bad FICO scores (699 and below) may have trouble qualifying for cards with the best terms. Compare your FICO score to these credit score ranges to see how your credit stacks up:
- Excellent credit: 760 and up
- Good credit: 700 to 759
- Fair credit: 650-699
- Bad credit: 300-649
If your score isn’t where you want it to be, take some steps to improve it over time. Above all else, those steps should include paying all of your bills on time, paying off as much of your debt as possible, and taking care of any delinquent accounts or inaccuracies on your credit report.
Once you do, credit reporting agencies will take note and adjust your score accordingly.
How to Avoid Paying Credit Card Interest
If you hate the idea of paying credit card interest on your purchases, and the thought of calculating credit card interest gives you a headache, there’s one tried and true method to avoid both every time. Pay your balance on time and in full every month, and you’ll never have to pay or calculate credit card interest again!
That’s right: Staying out of debt is the only true way to avoid paying interest on your purchases. Here are a few tips that can help you avoid paying interest altogether:
Set a reminder to pay your bill early: All credit cards offer a 25- to 30-day grace period where you won’t be charged interest on your purchases. Paying your bill in full before your due date can help you avoid paying interest altogether.
Only charge what you can afford to pay off each month: If you’re worried about overspending, only use your card for purchases you have enough cash in the bank to pay for. One way to keep track is to carry a notebook in your pocket and write down each purchase you make on credit.
Take advantage of a 0% APR balance transfer offer: If you’re paying too much interest on a balance, you might want to consider transferring your balance to a different card with better terms. Some cards even offer 0% APR on balance transfers for a limited time, which can buy you time to pay down your balance more aggressively.
Use your card only in emergencies: If you’re still worried you’ll overspend, it might be wise to save your credit card just for emergencies. For everyday purchases, stick to cash or use a debit card connected to your bank account.
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