Take a look at your most recent credit card statement. Right below the lines for “balance,” “minimum payment due,” and “payment due date,” you’ll find the Minimum Payment Warning, which reads something like this: “If you make only the minimum payment, you will pay more in interest, and it will take you longer to pay off your balance.”
Below the Minimum Payment Warning, you’ll see a 3 x 2 table that reveals the time needed to pay off your balance in full under two payment scenarios: one in which you make only the required minimum payment each month, and one in which you make a slightly higher monthly payment. Both scenarios assume you don’t make any further charges.
The second scenario results in a much faster payoff and much less in total interest owed. That underscores the importance of paying more than the minimum each month. After all, if we look hard enough, most of us can find a few extra dollars in our monthly budgets.
It also begs the question: How much do we really know about how credit card finance charges are calculated? Keep reading to learn how to calculate your credit card interest rate — and why it’s so important to pay off those balances as quickly as you can.
How to Calculate Your Monthly Credit Card Interest
Calculating your monthly credit card interest is a three-step process that requires only simply arithmetic — although you’ll want a calculator handy.
Step 1: Calculate Your Daily APR
First, calculate the rate at which your credit card balances earn interest each day. This is officially known as the daily periodic rate but is commonly referred to as the daily annual percentage rate or daily APR.
Find the Current APR on Your Credit Card Statement
Start by locating the current credit card APR on your monthly statement.
It often appears near the bottom of the bill, after the details of your charges, credits, and other account activity. If you don’t see it there, look toward the top of the statement, near the statement dates, total charges, and minimum monthly payment.
Divide the Current APR by 365
Next, divide your current APR by 365 — the number of days in a normal year. For example, if your current APR is 19.99%, you’d perform a two-step calculation to first convert the percentage rate into a decimal and then to find the actual daily periodic rate:
19.99 ÷ 100 = 0.1999
0.1999 ÷ 365 = 0.00054767
This seemingly small number is the rate at which your credit card balance increases each day due to interest. Your calculator will probably show more numbers to the right of the decimal point, but those won’t meaningfully change your interest calculation.
Step 2: Calculate Your Average Daily Balance
Now it’s time to calculate your average daily balance. This is the daily share of your statement ending balance. You can think of it as the average rate at which your credit card balance increases during the billing period.
Add Up the Daily Unpaid Balances on Your Credit Card Statement
First, calculate the average daily unpaid balance on your credit card bill. This is a time-consuming and tedious calculation that needs to account for:
- Any charges made during the billing period
- Any previous balance carried over from prior billing cycles
- Any credits that reduce your balance, including payments and chargebacks (refunds)
Begin with the starting balance on your credit card statement, if any. This is the unpaid amount carried over from the last billing cycle.
Then add the charges made on the first day of the period and write down the new total. Add the second day’s charges to this amount and write down the new total. Do this for every day in the billing cycle, making sure to subtract any credits on the day they hit the account. When you’re done, add up all of your daily totals.
Divide the Total Unpaid Balance by the Number of Days in the Billing Cycle
Next, divide this sum by the number of days in the cycle. Usually, this is 30 or 31 days. If you can’t find the number itself, use the statement start and end dates to calculate it manually.
Let’s say your total unpaid credit card balance for this statement cycle is $20,000 after accounting for all credits. Your billing cycle is 30 days long. Your average daily balance is:
$25,000 / 30 = $833.33
Your average daily balance should be in the ballpark of your statement ending balance but probably won’t be identical. Still, this is the amount that your credit card issuer bases your interest calculation on, so it’s vital to have.
Step 3: Multiply Your Daily APR & Average Daily Balance
Now it’s time to calculate your daily credit card interest. Do this by multiplying your daily interest rate and your average daily balance.
Using the example above, you’d perform the following calculation:
$833.33 * 0.00054767 = $0.45639
There’s just one more step to find how much interest your credit card debt accrued this month. You need to multiply your daily interest by the number of days in the billing cycle:
$0.45639 * 30 = $13.69175
You can round the result off after the first two digits after the decimal point. And we get a grand total of $13.69 in new interest this statement cycle.
How Credit Card Interest Works
Credit card interest accrues every day you carry a balance beyond your grace period, which extends anywhere from 21 to more than 30 days after your statement date.
As long as you pay your balance in full before the end of the grace period, you won’t pay any interest on charges made that month. If you carried a balance from the previous statement period, interest will continue to accrue on it during the grace period.
The grace period applies only to regular credit card charges, not balance transfers or cash advances. Those types of transactions start earning interest right away.
When your charges do start earning interest, the concept of compounding comes into play. You can think of compound interest as earning interest on interest — that is, the interest earned over the previous compounding period is added to your balance and increases the amount on which interest is charged.
Some credit card issuers compound interest on a daily basis. Others compound monthly. The more frequent the compounding rate, the more interest earned, although the difference between daily and monthly isn’t huge.
Why You Should Know Your Credit Card Interest Rate
Your credit card interest rate plays an important role in determining the total cost of your credit card usage.
A higher interest rate means unpaid balances grow more quickly, losing you more money every day you don’t pay them off. A lower interest rate might sound like a better deal, but your balance still grows faster than the inflation rate.
Knowing your credit card interest rate helps you manage your finances better too. When you know exactly how much interest your unpaid balance accrues over time, it’s easier to chart a course to pay down that balance and get out of debt.
How to Reduce Your Credit Card Interest
If you have significant credit card balances, you can’t just flip a switch and zero out your debt. But you can take steps to lower your credit card interest rate and reduce the amount of credit card interest you pay over time.
You can reduce your credit card interest without getting rid of your credit cards entirely. Many credit card companies are happy to negotiate lower rates if they have reason to believe you’ll default.
However, if you have the option, swapping your credit card debt for less costly debt could be a better deal. You can:
- Apply for a 0% APR balance transfer credit card and transfer higher-interest balances
- Take out a home equity loan or line of credit and use it to pay off your credit card bills
- Get an unsecured debt consolidation loan with a lower interest rate than your cards
You can also seek credit counseling and work out a debt management plan, which may reduce the total interest and fees you pay on your credit card debts.
Interest isn’t the only cost you may incur with regular credit card use. Most cards carry non-interest fees that kick in under certain circumstances. These include:
- Annual Fees. Credit card companies charge annual fees to secure your membership for the coming 12-month period.
- Balance Transfer Fees and Cash Advance Fees. Your issuer may charge these fees when you transfer balances from other credit cards or use your card to withdraw cash at an ATM.
- Foreign Transaction Fees. Many issuers charge fees on purchases denominated in foreign currencies, including online purchases with international vendors.
- Late Payment Fees. If you miss your payment due date, you could face a one-time fee.
- Returned Payment Fees. If you don’t have enough money in your bank account to cover your payment, you could face another fee.
With discipline, you can minimize these common credit card fees or avoid them altogether without cutting up your cards. Unfortunately, unlike interest charges that you can eliminate by making timely, in-full payments, some card fees can’t be avoided.
The only sure way to evade them is to choose a card with no mandatory fees or swear off credit cards altogether and miss out on potentially valuable perks, benefits, and rewards.