How to calculate credit card interests?
Credit cards are a popular way to borrow money on a needed basis at the point of sale to cover a purchase. However, such convenience comes at a price. Your card issuer charges you interest on any balance carried on the card from month to month.
Understanding how credit card interest charge is calculated can help you figure out how to reduce or avoid accruing interest on your credit card.
What is the interest rate for a credit card?
The interest rate for a credit card is the fee charged by the credit card company on the balance you carry on your credit card from month to month. In other words, it’s the price you pay to compensate the issuer for using their money and is usually expressed as an annual percentage rate (APR).
Thus, it’s vital to make sure that you pay off your balance every billing cycle or at least make the minimum monthly payment to avoid sinking into unmanageable debt or damaging your credit score.
Interest rate vs. APR
Though interest rate and APR are commonly used interchangeably, they have a slight difference. Annual percentage rate (APR) is a blanket term referring to the total cost of borrowing money, including the interest rate and any associated fees charged on the loan.
Interest rate, on the other hand, is the percentage rate used to compute the finance charge on the borrowed amount, and does not include any other fees that come with the loan.
Thus, your APR is usually higher than the interest rate.
Credit card APR formula
APR = ((Fees + Interest)/Principal/n)*365, where:
Fees = total fees paid for the loan
Interest = total interest paid for the loan
n = number of days in the loan term
You may calculate total interest paid using the following formula:
A = (P * (1+rt)), where:
A = Total accumulated amount
P = Principal amount
r = Interest rate
t = time period.
APR is usually measured in percent, so don’t forget to multiply by 100.
Let’s take a look at the example. “John” wants to get a credit card with and his interest rate from the bank is 18%. His credit limit is $5,000, which means that the maximum principal loan amount he may have is $5,000. To get this credit card, John also needs to pay some fees for $50 in total. First, we need to calculate the interest John will need to pay: Interest = ($5000 * (1 + 18%* 1 year)) = $900. After we have figured out the total interest, we can simply calculate credit card APR: (($50 + $900)/$5000/365*365 = 0.19, or 19%.
Don’t confuse APR with APY!
Both APR and APY have to do with the interest rate, but they are different. While APR stands for annual percentage rate, APY stands for annual percentage yield.
APR is associated with credit accounts and is used to calculate the cost of borrowing. APY, on the other hand, is associated with deposit accounts and is used to calculate the interest earned if you put money in an interest-earning account for a certain period.
Thus, APR expresses the interest you pay when you borrow money, while APY expresses the interest you earn on deposit accounts.
How to calculate interests on a credit card?
Interest charged on a credit card can be calculated in 3 simple steps as follows:
Step1: Convert your APR to a daily rate
Since most credit cards have variable APR, interest on your balance is calculated and added to your balance daily. That means interest compounds on the original amount every day.
You can find information on how your issuer compounds your interest by reviewing the cardmember agreement on the section that says “How we’ll calculate your balance.”
Say your card has a variable APR of 20.24%. To arrive at your daily rate, divide 20.24% by 365 days.
20.24% / 365 = 0.055%, which is 0.00055
Step 2: Find your average daily balance
Each month, you’ll receive a monthly statement from your card issuer with information on transactions carried out during that billing cycle, and the amount carried over from the previous month.
Using the transaction information on your statement, write down the balance for each day. Then add all the daily balances and divide by the number of days in the billing period to arrive at your average balance.
Says the billing cycle includes five days, with balances of $200, $1000, $300, $500, and $250. Your average daily balance will be:
( $200+$1000+$300+$500+$250 )/5 = 450
Make sure you subtract any payments made when calculating your average daily balance.
Step 3: Calculate your interest charges
To arrive at the interest charged during the current billing cycle, multiply your daily rate by your average daily balance, then multiply the result by the total number of days in your billing cycle.
$450 x 0.00055 = $0.2475 per day.
Let’s say our billing cycle is 25 days, you’ll pay $0.2475 x 25, which is $6.1875
You’ll pay an estimated credit card interest of $6.2 during that billing cycle. This figure may vary slightly depending on whether your card issuer compounds interest on a daily basis.
How much interest will I pay on my credit card?
How much interest you’ll pay on your credit card comes down to 3 main factors, including your card’s APR, credit card balance, and monthly payments. With these values, you can easily compute interest paid on a credit card using a credit card interest calculator.
Simply input the credit card balance, APR and monthly payment to determine the total interest you’ll pay until the balance is paid off.
5 tips on how to reduce the interests you pay
Credit card interest can quickly add up and increase your cost of borrowing. Here is a rundown of five tips on how to reduce the interest you pay on your credit card’s balance.
Pay your balance in full every month
Credit card APR only applies to the balance carried on the card from one billing cycle to the next. Thus, you can avoid paying interest by making sure that you pay your balance in full every month.
Pay more than the minimum monthly payment
Credit card companies only require you to make a minimum amount per month, which can be anywhere from 1-5 percent of the borrowed amount.
While it’s tempting to pay only the required minimum monthly payment each billing cycle, paying more helps reduce the balance and the interest accrued on your debt.
Make multiple payments per month
Since your credit card interest is calculated based on your average daily balance, paying more than once per month helps reduce your interest charges.
Thus, you’ll pay lower interest if you make biweekly payments instead of one monthly payment.
Get a 0% intro purchase and balance transfer APR card
If you plan to pay off your credit card debt in the next few months, signing up for a 0% purchase or balance transfer APR card is a great way to slash interest on your card and only pay the principal amount.
Get a low-interest credit card for future spending
Paying your balance in full each billing cycle is great, but that’s not always the case. If you find yourself carrying a balance from month to month, going for a credit card with a lower APR is a wise move to help you reduce interest costs in the long run.
If I pay the minimum credit card payment, do I get charged interest?
Yes, you’ll pay interest on any balance carried on the card from month to month, and your interest will keep compounding if you only make minimum payments each billing cycle.
How to calculate the interest rate on a credit card monthly?
To find the monthly interest rate on your credit card, divide the card’s APR by 12. For instance, your monthly interest rate on a credit card with a 17.99% APR will be 17.99/12, which is 1.5%.
How to know my credit card interest rate?
You can find your credit card interest rate on your issuer's website. You can also find your credit card APR near the end of your monthly statement on the “Interest Charge Calculation” section.