Unless you’re one of those freaks of nature who always pays their credit card balance in full every single month (in which case, can we be friends?), then you’re probably paying interest on your credit card debt.
And if you don’t know how much interest you’re paying oy you’ve wondered how much interest you’re actually paying on your balance, then you’re not alone. After all, those statements can be pretty confusing! But never fear, we’re here to help.
So in this post, we’ll break down exactly how credit card interest is calculated and we’ll walk through an example of how to calculate the interest you pay on your credit card balance so that you can understand exactly what you’re paying—and maybe even save some money in the process.
Ready? Let’s do this!
First things first. A few basics on Credit Cards
What’s An Annual Percentage Rate (APR)
The annual Percentage Rate is the amount of interest that you pay on your credit card balance over the course of a year. But wait, didn’t we just say that credit card statements are confusing? That’s because most credit card companies use a method called “average daily balance” to calculate your APR. This means that they take your balance at the end of each day and averaged it out over the course of a month. So, if you have a balance of $1000 at the beginning of the month and a balance of $2000 at the end of the month, your average daily balance would be $1500.
Now that we know how APR is calculated, let’s talk about how it’s applied to your balance. Most credit cards have what’s called a “grace period.” This is usually 21 days from the end of your billing cycle during which time no interest will accrue on your balance. However, if you carry a balance from month to month, then interest will begin accruing as soon as your grace period ends.
How is interest applied to my balance?
Interest is applied to your balance in one of two ways: either daily or monthly. With daily interest, your credit card company will calculate the APR for each day and apply it to your balance at the end of each day. So, if your APR is 15% and you have a daily balance of $100, you will owe 15 cents in interest for that day.
With monthly interest, your credit card company will calculate the APR for each month and apply it to your average daily balance for that month. So, using our earlier example, if your APR is 15% and your average daily balance for the month is $1500, you will owe $22.50 in interest for that month ($1500 x 0.15 = $22.50).
Alright, now that we’re clear on APRs, let’s work an example:
An Example: Here’s how the math works:
Calculating Your Interest Manually
Assume you have a credit card with a $1,000 balance and an annual percentage rate (APR) of 15%.
1. Convert your APR to a daily rate
To calculate your monthly interest charge, start by converting the APR to a monthly percentage rate by dividing it by 12.
So in this case, 15% divided by 12 equals 0.0125.
2. Find your average daily balance
Assuming you’re only making minimum payments, and you haven’t used your credit card anymore then your average daily balance is going to be your original balance of $1,000
If you had been using your credit cards then it would be adding up all your charges (subtracting any payments you made) and then dividing by the number of months.
3. Calculate your interest charges
Next, multiply your monthly percentage rate by your average daily balance.
Let’s keep with the $1000 charge, with no additional charges example. So that’s $1000 multiplied by 1.02 (which factors in two additional months of interest at the end of the year).
Therefore, 0.0125 times $1,000 times 1.02 equals $12.50.
Finally, take that number and multiply it by the number of days in the month to get your monthly interest charge. In this case, there are 31 days in January, so $12.50 times 31 equals $387.50.
And that’s it! That’s how much interest you’ll pay on your credit card balance for the month of January if you only make minimum payments.
Calculating Your Interest With A Tool
Another way you can calculate your interest charges is to use a tool.
Here are some calculators that you can use to determine how much you’ll pay in interest if you only pay the minimum
Credit Card Calculator – see how long it’ll take to pay off if only the minimum
Credit Card Amortization Schedule – Credit Card Calculator – if you make a specific monthly payment
Paying interest on your credit card sucks, but it doesn’t have to be a mystery.
We hope this quick primer has helped demystify some of the confusion surrounding credit card interest rates! Now that you know how it’s calculated, you can better understand how much interest you’re actually paying—and maybe even save some money in the process.
By following the steps outlined above, you can easily calculate how much interest you’ll pay in any given month. And once you know how much interest you’re paying, maybe you’ll be motivated to pay off your debt once and for all! Who knows? Stranger things have happened…