When it comes to credit card basics, the most critical concept to master is how interest is calculated. Most card issuers calculate interest charges using the “average daily balance,” which means your interest is calculated daily. By understanding how often your interest is calculated, you will be able to find out how much you will owe.
Even if you don’t manually calculate interest on your credit card, it’s important to understand how issuers determine your interest charges. At the end, we’ve added our interest calculator to make this process easier for you. This guide will help you clearly understand each step of the calculation and provide you with key terms you need to know.
How does credit card interest work?
credit card interest is applied to your statement if you don’t pay your balance in full by your payment date. To find your interest rate, you’ll want to look at the annual percentage rate APR on your card. There are likely to be different APRs depending on the transaction, such as purchases, balance transfers, and cash advances., The purchase APR is the most common interest rate, and as the name suggests, the purchase APR is charged at the items you buy with your card.
how to calculate credit card interest, step by step
calculating credit card interest can be a complicated process. There are four steps to the calculation, and finding your average daily balance will be the hardest of all. Requires you to know exactly what your balance was at the end of each day during the last billing cycle.
Step 1 – Find out how often your credit card interest compounds
The first step is to find out how often your credit card interest compounds – how often the interest is added to your original balance. Most credit card issuers will add interest daily, though you can find out what your particular issuer uses in your card’s pricing information.
You’ll want to look for the line “How We Will Calculate Your Balance.” If, for example, the issuer uses a method called “balance daily,” this means your interest is compounded daily.
Step 2 – Divide your card’s Annual Percentage Rate (APR) to get the Periodic Rate
Next, you’ll want to find the periodic rate, which will help you understand how much interest you’re paying on a balance per period.
if your issuer uses a daily balance, it will divide the APR by 365 days. If the APR is compounded monthly, divide it by 12 months. For example, an APR of 14.99% compounded daily would have a periodic rate of (14.99% / 365) = 0.00041, or 0.041%. This percentage is your periodic rate, which is the APR divided by the number of periods in your balance.
periodic rate
APR/number of periods
Step 3: Find your average daily balance
To find your average daily balance, you’ll need to know precisely what your end-of-day balance was each day within a billing cycle. This can be the hardest part of calculating your interest, as your balance can change from day to day and can be especially tricky if you use your card frequently., (If you put new charges on your card every day in a month with 31 days, you would have to calculate the balance at the end of the day for 31 separate days.)
For example, let’s say you had a balance of 3,300 on your card for the first three days, a balance of 5,500 for the next 15 days, and finally up to $1,000 for the last seven days. Your average daily balance would be $616. This number is calculated using the following formula:
average daily balance
(Day 1 Balance + Day 2 Balance + Day 3 Balance) / Total number of days in the billing cycle
Step 4 – Put It All Together
now, you’re ready to put it all together. You’ll multiply the periodic rate from Step 2 by the average daily balance from Step 3 and the number of days in your billing cycle. The result is the interest accumulated by a credit card during a given period.
Most credit cards will have a minimum interest charge. The amount varies by bank, but is generally between $1 and 2 2. So if you follow the calculations outlined here and you get an interest charge of 0 0.50 , you’ll pay the minimum interest charge instead.
example calculation
To help you visualize this formula, we’ve provided an example calculation for a card that calculates interest on a daily balance. We assume that this card comes with an APR of 14.99%. Here is the card activity in a given month:
To calculate the average daily balance, we multiply the number of days by your balance at the end of the day.,
((4 * $0) + (6 * $200) + (3 * $250) + (5 * $750) + (1 * $350) + (6 * $550)) / 25 days = 74
To calculate interest for the 25 days, we multiply the average daily balance by the daily periodic rate and the number of days in the billing cycle.
To calculate the daily periodic rate, we divide the APR by 365 days (14.99% / 365 = 0.041%).
Since there are 25 days in the billing cycle, we can now put all of these numbers together. We multiply the average daily balance, the daily periodic rate, and the number of days in the billing cycle to get the interest charge of $3.83.,
what you need to know about credit card grace periods
If you’re looking to avoid credit card debt altogether, issuers will generally offer cardholders a defined period to pay off their balance. Throughout this grace period, any new purchases added to the balance will not accrue interest. When you pay your credit card bill within this grace period, you will not be charged any interest.
under the Card Act of 2009, you have 21 days to pay your balance before interest begins to accrue. This period applies from the time your bill is delivered to you, either by mail or electronically. If your due date falls on a weekend or federal holiday, you will have until the next business day at 5 pm to submit your payment.
tools to help you visualize your credit card interest
Now that you understand how your credit card interest works, you may want to use an automated tool to make your calculations easier. Our Credit Card Interest Calculator allows you to add as many credit card balances as you’d like below, along with with your interest rates and the type of monthly payments you make. The calculator will show what your total interest payments will be by the time you pay off your debt in full.
