Here’s How Credit Card Interest Is Calculated
Credit card interest is often discussed, but not always understood. Despite the number of people who keep a credit card (or several) in their wallet, not everyone can explain the math that goes on behind the scenes.
Understanding how your monetary tools work is an important part of financial literacy, which is why in this article, we’ll break down credit card interest into basic dollars and cents.
What is a credit card’s interest rate?
Interest is the money a financial institution charges for money lent, or for the delayed repayment of that money. Measured using a percentage, your interest rate is shown on as “APR,” or “Annual Percentage Rate.”
Loans and credit cards have common ranges, with many credit cards having an interest rate between 12%-24% APR. The higher the rate, the more money you will potentially pay in interest.
Some credit cards have promotional offers of a 0% introductory interest rate, meaning that interest will not accrue for a fixed amount of time. These promotions can save borrowers money in interest payments, but be sure to read the fine print to make sure that interest is not just being deferred.
How do I calculate monthly credit card interest?
According to the Federal Reserve, the 2021 average interest rate for credit cards with balances that assessed interest was 16.45%. We will use this number as our APR in the following example, within a 30-day billing period, and starting with a leftover balance from previous months.
The first step in to calculate monthly interest is to find your daily periodic rate.
Despite how the name “Annual Percentage Rate” sounds, interest is calculated daily, not annually. You can locate your credit card’s APR on your billing statement, online banking, or credit card documentation.
| Step 1: Divide the APR by 365* to get your Daily Periodic Rate. | |||
|---|---|---|---|
| 0.1645 / 365 = 0.00045 | |||
*Some issuers divide by 360
Tip: Remember to move the decimal point two places left when working with percentage and whole numbers! In the above example, to divide 16.45%, enter 0.1645 into your calculator.
The next step is to determine the sum of your daily balances.
To start, take any leftover unpaid balance from previous months, then add each day’s total balance from the billing period. Your statement will tell you which days are included within the billing period, and only the days within that period will determine your interest charge for that month.
| Step 2: Calculate the sum of your daily balances by looking at your statement. | |||
|---|---|---|---|
| Day | Transaction Type | Amount | New Balance |
| 1 | Unpaid balance | $1,100 | $1,100 |
| 2 | Charge | $150 | $1,250 |
| 3 | Payment | -$500 | $750 |
| 4 | None | N/A | $750 |
| 5 | None | N/A | $750 |
| 6 | None | N/A | $750 |
| 7 | None | N/A | $750 |
| 8 | Charge | $300 | $1,050 |
| 9 | Charge | $50 | $1,100 |
| 10 | None | N/A | $1,100 |
| 11 | None | N/A | $1,100 |
| 12 | None | N/A | $1,100 |
| 13 | None | N/A | $1,100 |
| 14 | Charge | $100 | $1,200 |
| 15 | None | N/A | $1,200 |
| 16 | None | N/A | $1,200 |
| 17 | None | N/A | $1,200 |
| 18 | Charge | $250 | $1,450 |
| 19 | Charge | $75 | $1,525 |
| 20 | Payment | -$500 | $1,025 |
| 21 | None | N/A | $1,025 |
| 22 | None | N/A | $1,025 |
| 23 | Charge | $50 | $1,075 |
| 24 | Charge | $100 | $1,175 |
| 25 | Charge | $75 | $1,250 |
| 26 | None | N/A | $1,250 |
| 27 | None | N/A | $1,250 |
| 28 | None | N/A | $1,250 |
| 29 | Charge | $100 | $1,350 |
| 30 | None | N/A | $1,350 |
| Sum of Daily Balances | $33,450 | ||
Find your average daily balance by taking the sum of daily balances and dividing it by the number of days in the billing period.
| Step 3: Calculate the average daily balance in your account during the billing period. | |||
|---|---|---|---|
| Sum of Daily Balances / Days in Billing Period = Average Daily Balance | |||
| $33,450 / 30 = $1,115 | |||
Finally, calculate your interest charge by multiplying your average daily balance by the daily rate you determined in Step 1. Then, multiply that result by the number of days in the billing period.
| Step 4: Calculate the interest. | |||
|---|---|---|---|
| Average Daily Balance x Daily Periodic Rate x Days in the Billing Period = Interest Charge | |||
| $1,115 x 0.00045 x 30 = $15.05 | |||
Final interest charge for the billing period: $15.05
With these calculations, you will see that a 16.45% interest rate on a balance of $1,350 doesn’t mean you’ll be paying 16.45% ($222.08!) in one month’s interest, but in fact a fraction of that.
While it is important that you understand the math behind credit card interest, there’s no need to do these calculations by hand each time! Create a spreadsheet template with your numbers and keep track of your credit card spending over time. Being aware of your budget helps foster healthy habits.
How to Pay Less Interest
The best method to avoid paying interest entirely is to pay off your balance in full each month. Of course, this may not always be possible due to individual financial situations, in which case the next best course of action would be to pay as little interest as you can.
Making payments early or making multiple payments per month can lower your average daily balance. You can experiment with how this affects your interest charge by plugging different numbers into the calculations above.
If you frequently carry a balance, a low interest credit card from American Heritage could help save you money in interest! Plus, earn Scorecard Rewards Points with every purchase to get even more from the tools you use the most. Visit us online or stop into your local branch to learn more.