How is Credit Card Interest Calculated?

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Since credit card debt has some of the highest interest rates out there, it’s important to know exactly what you owe. But before calculating your credit card interest, there are a few general things you should know first. You need a good grasp on how exactly this interest is charged, and how often!

The first step to tackling your debt is knowing exactly what you owe. With credit cards, this can be difficult. So many factors come into play – credit score, cash advance balances, transfer balances, the prime rate, and more! But once it’s broken down, I promise it does make sense.

In this article:

  1. What is the interest rate on my credit card?
  2. Different types of Annual Percentage Rates
  3. When am I charged interest on my credit card?
  4. Your credit card interest calculated in three steps
  5. How do I avoid paying interest on my credit card?

Heads up: you might need your most recent copy of your credit card statement before reading. There is a lot of useful information on this statement that often goes unnoticed!

What is my interest rate on my credit card? 

Your credit card interest calculations are based around your Annual Percentage Rate, or APR. This is a highly personalized number, varying depending on your card, your credit score, and your past finances. But an APR is typically 15-20%.

Where can I find my Annual Percentage Rate?

Since APR is different for each person and each credit card, you’ll need to find your own specific rate. Usually this can be found on the credit card company’s website. However, if you have certain charges on your card, this can alter your APR.

To be sure, it’s best to check your online banking account or refer directly to your monthly credit card statement.

What is my Annual Percentage Rate?

Credit cards will either have a fixed APR or a variable APR. Be sure which one is used before signing on to a credit card!

A fixed APR will stay the same, save for some specific situations. For example, you could be put on a penalty APR if you are 60 days late on your payment. You could also have a promotional rate, which will change after the allotted time period.

Since the economy is fickle, a variable APR is much more common. Many companies take the prime interest rate as a base level, and then add a margin on top of that. This means your APR is bound to fluctuate as the prime rate does.

Beyond fixed or variable, there are a few additional APRs that can further complicate your rates.

Different types of Annual Percentage Rates

Even under one card, you could be subject to a variety of interest rates depending on the type of purchases you make. Before your credit card interest is calculated, you need to know which interest applies to each transaction. 

Purchase APR

This could be considered the “basic” APR, because it refers to the interest charged on any credit card purchases. This rate is also used to add interest to any outstanding balance on your monthly statement.

This is the rate you would find on your monthly credit card statement, and the one you’ll most use when your credit card interest is calculated.

Balance transfer APR

If you’ve decided to switch credit cards and transfer your balance, this likely has an affect on your APR. Any funds transferred would have insurance compounded based on your Balance Transfer APR, which would be at a higher rate.

Cash Advance APR

Most of us know that cash advances on our credit cards come with a price – the price of higher interest rates.

If you’ve taken money from your credit card to either pull out cash or add funds to your debit account, this borrowed money will be charged at a much higher interest than your regular Purchase APR.

Introductory or Penalty APR

Purchase, Balance Transfer, and Cash Advance APRs are common and you’re likely to run into them along your credit card journey. Introductory and Penalty APRs are sometimes less common.

An introductory rate is a promotional rate. Often credit cards will offer a lower APR for the first few days to entice new sign-ons. This can be dangerous because although appealing, the APR after the promotion runs out could be especially high.

You could also be put on a Penalty APR if you are 60 days late on your minimum payment, or if you otherwise violate terms and conditions on your card. This is a much higher rate than usual.

Often, you need to make consistent payments for 6 months before you can convince your bank to lower your rate again. So it’s best to not be late in the first place! If you tend to forget about credit card payments, try automating your payments.

What influences my Annual Percentage Rate?

Obviously, the type of card you sign up for will have an impact on your APR. Rewards cards or travel cards will often have a higher APR in exchange for other card-holder benefits. For example, the Tangerine Money-Back Credit Card has an average APR, but they make up for it with some awesome cash-back features.

Your credit score and payment history will also have a big impact! If you often pay your credit bill late and if your credit score is on the low side, most credit card companies won’t qualify you for their average APR.

Essentially, your credit card mistakes hang over you! You’ll be stuck paying a higher APR until you can fix your credit score. Just another reason to stay on top of your payments, and check your score regularly.

If your APR is a variable rate (it likely is), then it’s subject to change. If certain economic factors lead to the prime rate fluctuating, it’s more than likely your APR will follow suit.

Could I end up paying more interest than my Annual Percentage Rate?

Yes! Compounding interest is usually at a more accelerated rate than the APR might imply.

This is why it’s important to pay off your credit card debt sooner rather than later. Otherwise you could end up paying much more interest!

Your interest-free grace period

Another thing to keep in mind before calculating your credit card interest is you interest-free grace period. Many credit cards do not actually start charging interest on new purchases for the first 21 days.

Keep in mind, grace periods are not required! Do not assume a grace period comes with a new card. Make sure you have one before accounting for it when calculating your credit card interest! 

If you purchase a credit card with a grace period new, you can use it without incurring interest at first. This means your first month’s statement will only include a week’s worth of interest gained.

However, if you already have a balance on your credit card and you make a new purchase, often it will begin accruing interest right away. This is just another reason to pay off your credit card in full each month!

When am I charged interest on my credit card?

Monthly.

Although interest is calculated on your card daily, you aren’t charged that amount until your statement is issued each month.

The day of the month your statement is issued is different for everyone, but you should be able to see it on your online banking account.

Your Credit Card Interest Calculated in Three Steps

Okay, now that the rules for APR are out of the way, onto the math! Bear with me.

Before calculating credit card interest, you’ll need to know your purchase APR, your average daily balance, and the number of days in your billing cycle. 

One big misconception when it comes to credit card interest is that because it’s charged monthly, it’s also calculated monthly. This isn’t true! Your interest is calculated every day, even if you don’t see it on your online account yet.

Although APR is based on annual numbers, it’s used to calculate interest in each of your monthly statements. For this reason, you’ll want to convert it to a daily percentage rate it order to properly calculate credit card interest.

Step One: Convert APR to a daily percentage rate

The math here is pretty simple. Divide your APR by 365, the number of days in a year. With this number, you can know how much your balance will raise even before your monthly statement comes in.

PS: Keep in mind that these numbers won’t likely be exact. Some banks divide APR by 360, instead of 365.

This daily rate is called your periodic interest rate, or sometimes your daily periodical rate.

0.15/365 = 0.000410

Therefore, if your APR is 15%, your periodic interest rate is 0.041%.

Step Two: Determine average daily balance

Check your credit card statement to see which days are included in your billing period. Your interest charge depends on the balance for each of these days.

Start with your unpaid balance carried from the month before. Any purchases on your credit card in the most recent billing period raises your balance, while any payment against your card lowers it. 

Credit card balance + Purchases – Payments 

Go day by day for the entire billing cycle, starting with your card balance. Say your balance is $1,000. Then add every purchase on top of that $1,000, and subtract any payments you made against that $1,000.

Do this for each day, then add the balances together. Divide this by the number of days in your billing cycle, and you’ll have your average daily balance! 

In this example, let’s say the average daily balance on a credit card is $500. 

0.00041 x 500 = 0.205

With a purchase APR of 15% (therefore a daily percentage rate of 0.041%), we can calculate how much interest is incurred each day. In this example it’s only twenty cents! 

Step Three: Convert into a monthly dollar amount

Obviously, knowing you incur twenty cents of interest every day isn’t necessarily helpful. It’s hard to do anything with numbers like those.

Converting into a monthly dollar amount allows your to see the exact value of any interest that will be charged in a month.

This is as easy as multiplying your average daily interest with the number of days in a billing cycle! A billing cycle is usually 30 days, but make sure to double-check so you aren’t charged late fees. 

0.205 x 30 = 6.15

So every month, $6.15 worth of interest is incurred. In other words, that’s over $73 per year. 

You will be charged interest on your interest

Credit card interest compounds!

You are not exclusively charged interest on each new purchase. The interest you incur gets added to your balance, and then you begin incurring interest on that. 

Each billing cycle that passes with interest on your card, the more interest you’ll be charged the following cycle.

This is why people get trapped in a cycle of debt and their balances get out of control. When calculating credit card interest, compounding has a huge impact on your balance owed. 

Do I pay interest if I make the minimum payment?

Yes!

You pay interest on any balance that you carry forward. This means that any balance on your credit card is always incurring interest. 

Even if you are consistently making minimum payments, interest is being charged on whatever balance your card carries.

How do I avoid paying interest on my credit card?

The whole idea with a credit card is you take on interest charges in return for access to funds you don’t really have. Unless you aren’t carrying a balance at all, interest incurred is unavoidable! 

The only real way to avoid paying interest on your credit card is to pay off the balance in full. But we also know that a credit card balance is necessary for many, especially if you live in poverty.

Even without paying off your balance, there are a few ways to lessen the load of credit card interest.

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Transfer your balance to a 0% card

The first option is to transfer your balance! Although you will likely have to deal with a Balance Transfer APR, it could be worth it depending on the card you switch to. Especially if your current card has a ridiculously high interest rate. If your transfer your balance to a 0% card, your overall rate will still be lower! 

Negotiate new rates

If you have been on time with your payments or your credit score has recently improved, it’s likely that you’ll be able to negotiate your rate. Usually credit card companies want your minimum payments paid on time for at least 6 months straight before they will hear you out on negotiating a lower rate.

If your credit score is 750 or more, you should be low-risk and qualify for a low APR. 

Remember that you’ll likely need to ask for a lowered rate. Your credit card will love charging you crazy rates for as long as possible! If your credit score improves, they wont reach out to you and offer a reward for such. 

Watch your credit card use

Now that you know about Penalty APRs, Balance Transfer APRs, and Cash Advance APRS, you know to avoid them!

If your restrict your credit card use to only purchases, you’ll only be dealing with your lowest possible APR. Combine this with making regular payments, and shedding your credit card balance whenever you can, you’ll be paying the least amount of interest possible on your credit card!

Credit card companies tend to rely on the confusion behind their rates and charges. If a customer doesn’t know the ins and outs of the process, they could end up paying thousands more against their credit card debt than needed. 

Stay updated by keeping your credit card interest calculated to give the banks as little of your money as possible! 

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About Author

A professional writing student at York University, Toronto. A newbie in the world of personal finance, but writing with MAG I've got the perfect teacher! Literary nerd, writer, and coffee enthusiast.

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