Last updated on November 3rd, 2020
Credit card debt is a crushing reality for anyone that doesn’t pay their credit card balance from month to month. Fortunately, knowing what interest charges actually are and how credit card interest is calculated can give you the knowledge to get out of debt faster. Interested in learning more about interest? Read on.
What is credit card interest?
Credit card interest is more than a monthly line item in your statement or a number printed on the credit card issuer envelopes you still receive via snail mail. Quite simply, it is the fee that you pay for the ability to borrow money. This interest rate is known as an annual percentage rate or APR. These APRs can also be fixed, which means they generally stay constant, or variable, which can change at any time with the Prime Rate. Aside from those factors, there are also different kinds of APRs that are calculated with each credit card, including a balance transfer APR, cash advance APR, and a penalty APR that is imposed when your payment is late, often after a grace period of 60 days or more. If you completely pay off your credit card balance before your billing cycle due date, then you’re in the clear here. Otherwise, you’ll be paying interest on the remaining balance while paying it down. Credit card companies offer cards with a higher or lower interest rate and a whole slew of different benefits. Ideally, you want to find a credit card with an APR and benefits that are perfectly balanced, as all things should be.
How is credit card interest calculated?
There’s no reason to be intimidated by the thought of calculating your credit card interest. The three main things you’ll need to know in order to calculate the interest you’ll be charged is your APR, your average daily balance, and the number of days in your billing cycle. If you’re looking at your billing statement now, you already have those. Here’s how to determine the rest: To calculate your daily periodic rate, divide your annual percentage rate by 365 (the number of days in a year). If you have a credit card with a 17% APR, it’ll look like this:
0.17 / 365 = 0.00047
Next, multiply your daily periodic rate by your average daily balance. If you’re carrying daily balances of $1,200 on your credit card, let’s say, the calculation will be:
0.00047 x 1,200= .56
Finally, take that last value calculated and multiply it by the number of days in your credit card billing cycle. If you have a 30-day billing cycle, which is average, the calculation will be:
.56 x 30 = 16.80
That means that with a 17% APR credit card, carrying an average balance of $1,200 each month, with a 30-day billing cycle, you’ll be paying $16.80 in interest.
Why does credit card interest and knowing how to calculate it matter?
So you’ve used math for the first time since you were out of school and not calculating a tip at a restaurant. So why does any of that matter?
Interest is money you’ll never get back.
As stated earlier, interest is just the fee for the ability to borrow money, like the rent you pay to live in an apartment someone else owns or the charge for getting a ride downtown in someone else’s vehicle. At the end of the day, it’s money you pay for convenience’s sake, though the overlying problem still exists. If you only make a minimum payment each month over years of time, you may very well end up paying more in interest than the initial amount owed. Irresponsible behavior like not making your monthly payments on time can also affect your credit scores, which will affect the APR of cards you try to sign up for in the future and even which ones you’ll be able to qualify for at all. If you can pay your credit card balance on time, every time, just do it. You’ll be saving cash that can be used for more interesting aspects of life than interest.