Credit Card Q&A: “How to calculate credit card interest?”
One of the major drawbacks to using credit cards is the associated interest charged, otherwise known as finance charges in industry speak.
Credit card interest is calculated using APR, or annual percentage rate.
Typically, credit card APR ranges from 0% to 20% and beyond, depending on the credit card and your credit history.
It is imperative that you know your exact interest rate if you want to successfully calculate the interest due.
So how do you calculate credit card interest?
Well, there’s the simple way of calculating it and more intensive, exact way. First, lets look at the simple way, which I prefer being the lazy person that I am.
Credit card balance: $2,500
Credit card APR: 19.99%
For a good rough estimate, just multiply .1999 x $2,500 and divide by 12 to quickly figure out the monthly credit card interest.
You’d be paying roughly $41.65 per month in credit card interest if you carried the $2,500 balance during the entire month – that’s roughly $500 annually.
Of course, things will most certainly always be in flux as balances change, both up and down, so the method above is not the most accurate measure.
Now the complicated way:
If you want to be more exact, you have to figure out the daily periodic rate, by dividing your 19.99% APR by 365 (this is assuming your credit card issuer uses average daily balance to calculate credit card interest; most do).
Then you take this figure (0.000548) and multiply it by the average daily balance and multiply that by the number of days in the billing cycle.
Do the math: 0.000548 x $2,500 x 30 = $41.10
As you can see, the difference between the simple method and the complicated method for calculating credit card interest is minimal. So it may not be worth your time.
However, it can be more meaningful if your average daily balance changes. For instance, if you were to pay off half of your credit card balance 15 days into your billing cycle, your average daily balance would be $1,875.
15 days @ $2,500
15 days @ $1,250
Average daily balance: $1,875
Do the math: 0.000548 x $1,875 x 30 = $30.83
The savings aren’t immense, but they are significant. Credit card holders get into trouble when they make just the minimum payment each month.
In such cases, the credit card balance typically grows each month and more interest is due as a result. This is often referred to as the debt spiral.
You can see how it could accelerate and get nasty for the card holder over time. This is why credit cards are seen as traps that suck you in and never let you go (pros and cons of credit cards).
In summary, be sure to ask your credit card issuer what your interest rate is and what method they use to calculate credit card interest. You may find that they vary among credit card issuers. And your interest rate is likely variable, meaning it change for any number of reasons.
Tip: Which credit card should I pay off first?
All that math makes my head hurt! I’ll just keep paying my balance completely every month to avoid it!
That’s certainly the best approach.
This is why credit card companies make money hand over fist.