How Is Credit Card Interest Calculated?

When looking at your credit card bill, you may notice a few additions to your monthly payment. If you don’t pay your credit card balance in full by the due date, you will incur interest fees.

You might cringe at the thought of credit card interest, but don’t worry—interest rates aren’t necessarily a bad thing. Understanding credit card interest can help you use your credit card effectively and make smart financial decisions in the future.

Before you sign on the dotted line, take the time to learn how credit card interest is calculated.

What Is APR?

Annual percentage rate (APR) is your credit card’s interest rate, or the interest you pay in a given year. The APR for your specific card can be complicated, but every APR operates under two basic principles.

First, you can avoid paying an APR if you pay off your credit card bill in full. In other words, when you completely pay off your credit card balance every month, your card’s APR won’t be applied. But when you carry a balance over to the next month, interest will start to collect on your credit card.

The second principle is that the lower your card’s APR, the lower your interest. APRs vary depending on the credit card company and your credit score.

Remember that your APR doesn’t include compound interest, or the interest that collects on both your current balance and your accumulated interest from that balance. The interest that includes compound interest is referred to as your annual percentage yield (APY).

What Is a Variable APR vs. a Fixed-Rate APR?

There are two types of APRs—variable and fixed-rate:

• Variable APR:  This type of rate changes with the index interest rate, meaning your credit card’s APR could change, although your cardholder agreement will tell you exactly how often it changes and how it is calculated.
• Fixed-rate APR: This type of rate remains the same throughout a certain period. Keep in mind that while a fixed-rate APR won’t change along with an index, it can still change. The card issuer is required to give you notice before increasing the rate, typically monthly or quarterly.

Most credit cards offer variable rates.

Does a Credit Card Have More Than One APR?

Now that you have a basic understanding of APR, there are a few other types of APRs you should know about. Most credit cards have more than one APR, so you’ll have to read the fine print to see how many your card has. It could include one or more of the following:

• Balance transfer APR: This interest rate is charged to any balances you transfer to the card from other credit cards.
• Cash advance APR: A cash advance interest rate is often very high and charged on any credit card cash advance you take out.
• Penalty APR: If you want to dodge paying penalty interest, make sure to pay your balance on time to avoid late payments.
• Purchase APR: This interest rate is charged to items you buy with your card.
• Intro APR: This is a promotional APR that lasts for a certain period of time. It isn’t unusual for a credit card company to offer new cardholders a 0% intro APR for the first year or so.

What Is DPR?

Daily periodic rate (DPR) is another type of interest rate. Your daily periodic rate is the formula used to determine how much interest you pay on your credit card on each monthly statement.

In simpler terms, your DPR is your APR divided by 365 (the number of days in a year). And like APR, your DPR does not include compound interest.

How to Calculate Credit Card Interest

So, how is credit card interest calculated? Follow the step-by-step instructions below to calculate yours. Make sure you have your credit card statement available so you can pull the necessary information from it.

1.     Convert Your Annual Rate to the Daily Rate

To calculate credit card interest, you must first convert your card’s annual rate to a daily rate. To do so, divide your card’s APR by 365 (since there are 365 days in a year).

APR ÷ 365 = DPR

For example, if your card has a 19% APR, the formula would be:

0.19 ÷ 365 = 0.000521%

You can find your card’s APR on your monthly statement.

2.    Calculate Your Average Daily Balance

Since interest compounds daily, you need to calculate your average daily balance.

Look at your credit card statement and note each day’s balance, including any unpaid balances from the previous month.

Add the daily balances and divide by the number of days in the billing cycle.

(Day one balance + day two balance + day three balance, etc.) ÷ Number of days in the billing cycle

For the sake of this example, let’s say you didn’t carry over a balance and only made three charges throughout the month—a $300 charge on day seven, a $10 charge on day 10, and an $800 charge on day 22. Let’s also assume your credit card has a 30-day billing cycle.

In this case, the calculation would be:

($0 x 6 days) + ($300 x  3 days) + ($310 x 12 days) + ($1,110 x 9 days) ÷ 30 = $487

3.    Determine Your Interest Charges

Now, we’ll use the above numbers to calculate our credit card interest. First, multiply your daily rate by your average daily balance, and then multiply that result by the number of days in the billing period.

DPR x Average daily balance x Number of days in the billing period = Daily interest charges

Based on the example above, that would look like:

0.000521 x $487 x 30 = $7.61

While $7.61 may not seem like much, it can add up over time, especially if you spend a lot using your credit card. For example, if you had an average daily balance of $12,000, that would equal $187.56 in interest.

What Other Fees Do Credit Cards Carry?

Credit cards carry more than just interest fees. You can’t avoid most fees, but they vary, so don’t be afraid to shop around before settling on a card. You can expect to pay these common fees:

• Annual fee: Many cards charge an annual fee, although they often include benefits that may make the card worth the cost. You can also find credit cards with no annual fee.
• Balance transfer fee: If you choose to transfer balances between cards, you may need to pay an extra fee.
• Cash advance or withdrawal fee: If you decide to take cash off your credit card, expect to pay a fee—likely one that costs more than withdrawing from a traditional bank ATM.
• Foreign transaction fee: If you purchase an item in a foreign currency, your credit card may charge you a fee.
• Late payment fee: This fee is standard among all types of financial transactions, but may cost more on a credit card. Avoid this fee by paying your bill on or before the due date each month.

How to Pay Less Interest on Your Credit Card

After learning about credit card interest rates, you might be wondering how to keep your credit card interest at a minimum. Here are some ways to pay less interest on your credit card:

• Pay your monthly statement in full. Most credit cards offer a grace period during which you can pay your balance without incurring interest.
• Sign up for a 0% APR promotion. If you’re anticipating a large purchase, consider signing up for a credit card that offers a 0% APR period to give you time to pay down the balance without accumulating interest.
• Use your credit card sparingly. Consider only using your credit card when you absolutely need to, and budget for large purchases in advance.

Credit card interest FAQ

Is Credit Card Interest Monthly or Daily?

Most credit cards calculate interest on a daily basis; however, interest is only applied if you carry a balance from month to month.

What Is the Average Credit Card Interest Rate?

The average credit card interest rate is 20.92%, according to data collected by the Federal Reserve.

What Is a Good Interest Rate on a Credit Card?

The lower the APR, the better. If you have a good credit score, depending on other qualifying factors, you may be able to qualify for lower rates.

What Is a Grace Period?

A grace period is the time allowed for you to pay new charges. It typically runs from the end of a billing cycle to the next due date, around 21 days. Keep in mind that card issuers aren’t required to offer you a grace period, and some only offer the grace period if you pay off your entire balance each month.

How Do I Lower My Credit Card Interest Rate?

To lower your credit card interest rate, improve your credit score, then contact your issuers to see if you can negotiate a lower rate.

How Does My Credit Card Balance Affect My Credit Score?

Carrying a balance on your credit card will likely hurt your credit score. Credit utilization, or the amount of credit you’re using at a given time, accounts for 30% of your score. A lower credit utilization ratio shows that you’re managing your credit responsibly and not overspending. Most credit experts recommend keeping your credit utilization ratio under 30%, but the lower the better.

Need help staying on top of your credit so you can pay less interest in the future? ExtraCredit® provides you with top-notch credit coverage at an affordable price. Try it with our  free trial today.

 

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