How Does Credit Card Interest Work? Let’s Take the Mystery out of the Calculation
Updated November 16, 2023 at 2:55 pm
When talking finances, the subject of interest rates can quickly escalate to confusion and anxiety, especially in conjunction with credit cards. The numerous headlines outlining higher interest rates may not help, but understanding how credit card interest works may help put your mind at ease a bit. Once you know how credit card companies calculate interest and how it impacts your own budget, you’ll know what you’re dealing with and can make more informed credit decisions.
If you’re like the average person in the U.S., you probably have at least one credit card (if not multiple) or are considering opening your first account. No matter how confusing it might be, credit card issuers charge interest, which means it costs money to carry a balance each month. How much money are we talking about? Here’s how you find out.
What Is Credit Card Interest?
Put simply, credit card interest is the cost of borrowing money. With credit cards, not only do you see interest rates expressed as a percentage, but they’re also a yearly rate known as the annual percentage rate (APR). Interestingly—and perhaps causing more confusion—credit card companies use an APR, but calculate interest daily and then charge you each month.
Interest rates and APR are often used interchangeably with credit cards, but APR is a representation of the total cost of borrowing, including all fees, whereas an interest rate doesn’t include any fees.
When you use your credit card for a purchase, the financial institution pays the merchant and is essentially lending you the money. You pay the credit card company back when your bill is due, plus an interest charge and/or fees applied to the balance. If you don’t pay the balance back before the end of the billing cycle, your balance is subject to interest charges.
How To Calculate Credit Card Interest
If you’re budgeting or planning ahead for future purchases, you may be wondering how to calculate credit card interest on your own without waiting for a monthly statement. Or, perhaps you’re comparing credit cards and want to understand the monthly impact of having a different interest rate. Here’s how to calculate credit card interest:
- Locate your credit card’s APR: To find your credit card’s APR, log in to your online account or grab a copy of your paper statement—you should see the APR listed. Let’s assume for this calculation it says 22.15%.
- Calculate the daily rate: Once you know your APR, take the percentage and divide by 365. You do this because APR is an annual rate, and you need the daily interest rate for the calculation. So for our example, 22.16% divided by 365 is 0.061, your daily rate.
- Determine your average daily balance: This part gets trickier, but determining your daily balance means adding up all the charges for the billing cycle, or how many days you’re reviewing. Take the sum of all your charges for the period, plus any fees or minus any payments. Once you add these numbers up, divide the number by the number of days in the billing cycle. With our example, let’s assume we have $1,000 in charges and a 25-day billing cycle, the average daily balance is $40.
- Multiply the average daily balance, the daily periodic rate and number of days in billing cycle: Now you know your daily balance and daily periodic rate, which means you can calculate your interest charges. Multiply these two numbers together, then by the number of days in the billing cycle, and you’ll have your total interest charges for how many billing cycle days you specify. With our example, we multiply 0.061 by $40 by 25, which totals $61 in interest charges.
Can I Lower My Credit Card Interest Rate?
The good news is, that you can actively work to get your credit card interest rate lowered, but it does involve a few actions. For starters, paying your bill each month and avoiding any interest charges is the best approach if possible. If you can’t pay the bill in full, pay more than the minimum amount and ensure it’s paid before the due date. This will help you pay off your balance even faster than the date the credit card issuer posts on your account.
Another tactic is simply calling your credit card issuer and asking them for a lower rate. This is especially useful if you’ve received any offers from competing companies or have been a long-standing customer with good credit habits. The worst that can happen is the credit card company says no.
If you currently have a credit card with a high interest rate, consider transferring the balance to a card with a 0% introductory or promotional APR—this could save an enormous amount in interest charges in the long run, depending on the length of the offer and your balance. Even if you are unable to take advantage of a promotional rate, if you shop around and compare cards, you may be able to find and apply for one with a lower interest rate.
Frequently Asked Questions
Is Interest on a Credit Card Monthly or Daily?
Most credit card companies calculate interest charges on a daily basis, which means the interest gets added based on the previous balance from the day before. The interest charges from each day are then added up and lumped together for a monthly interest charge, which is what you see on your credit card statement each month.
Do You Get Charged Interest if You Pay the Minimum Payment?
Yes, you still get charged interest even if you make the minimum payment for your credit card. The minimum payment is simply the lowest amount you can pay to keep your account in good standing and avoid late fees.
Why Did I Get Charged Interest if I Paid Off My Credit Card Bill?
If you received interest charges after paying off your credit card bill, it’s most likely because you were carrying a balance or due to the timing of when the company received your payment. Credit card issuers charge interest on a daily basis, so you were likely charged once they sent the bill to when the company received your payment.
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