Katia Iervasi
Athena Cocoves
If your credit card has an annual purchase rate of, say, 18%, that doesn’t mean you get charged 18% interest once a year. Depending on how you manage your account, you may not even be charged interest at all. That’s because interest is calculated on a daily basis, not annually, and is charged only if you carry debt from month to month.
Knowing how credit card companies calculate interest can help you understand the true cost of your debt.
How to calculate credit card interest
How To Calculate Credit Card Interest
STEPS TO CALCULATE CREDIT CARD INTEREST
Calculating credit card interest is a three-step process. You can use an online calculator, but it’s good to know how to do it yourself. If you want to follow along, grab your credit card statement. You’ll need some information from it.
Convert annual rate to daily rate
Your interest rate is identified on your statement as the purchase rate per annum (p.a.). Your credit card issuer might refer to this as an annual percentage rate, or APR.
Since interest is calculated on a daily basis, you’ll need to convert the purchase rate to a daily rate. Do that by dividing by 365. Some banks divide by 360; for our purposes, the difference isn’t worth worrying about, as it changes the outcome by only a hair. The result is called the periodic interest rate, or sometimes the daily periodic rate.
Determine your average daily balance
Your statement will tell you which days are included in the billing period. Your interest charge depends on your balance on each of those days.
You start with your unpaid balance — the amount carried over from the previous month. When you make a purchase, the balance goes up; when you make a payment, it goes down. Using the transaction information on your statement, go through the billing period, day by day, and write down each day’s balance.
Once you’ve got that done, add up all the daily balances and then divide by the number of days in the billing period. The result is your average daily balance.
Put it all together
The final step is to multiply your average daily balance by your daily rate, and then multiply that result by the number of days in the billing period.
Depending on whether your issuer compounds interest daily or monthly, your actual interest charge might differ slightly from this calculated amount. Compounding is the process of adding the accrued interest to your unpaid balance so that you are paying interest on interest.
Compounding is the reason you could pay more than your annual purchase rate in interest. For example, say your average daily balance was exactly $1,000 for the entire year. If the bank had an 18% interest charge just once at the end of the year, you’d pay $180. But since your interest compounds, you’d actually be on the hook for something closer to $195.
Getting your first credit card?
Whether you’re a beginner or a credit card pro, make sure you know how to handle a credit card responsibly. It’ll save you time, money and frustration.
How does credit card interest work?
Credit card issuers charge interest on purchases only if you carry a balance from one month to the next. Generally, if you pay your balance in full every month and don’t make any cash advances, your interest rate becomes less relevant, as you are not likely to be charged interest at all. Obviously, paying in full is the most cost-effective way to go, but if you usually carry a balance or only make the minimum repayment, a credit card with a low rate, or none at all, can save you money on interest.
Depending on your card, you might have different interest rates for different kinds of transactions, such as purchases, balance transfers, cash advances and credit card repayment instalment plans.
You may also have an interest-free period, which typically gives you extra time to make your payment before interest is calculated. These periods typically last 45 to 55 days, but specifics vary. Check your card’s terms and conditions to see how it works for you.
What’s the average credit card interest rate?
The average credit card interest rate is 20.57%, according to July 2024 data from Reserve Bank of Australia (RBA)[1].
How do card issuers determine interest rates?
Most credit cards have a single purchase rate for all customers. Others have a range — for example, 13% to 23% — and your specific rate depends on your creditworthiness. The better your credit, the lower your rate.
The type of credit card can also influence the annual purchase rate. For instance, rewards credit cards tend to come with higher interest rates (and fees).
How can I lower my credit card’s interest rate?
You have control over some of the factors that determine your credit card’s interest rate. A better credit score may get you better credit card options. And if your score has improved significantly, you can try asking the issuer for a lower rate. But regardless of the stated APR on your card, you can reduce the amount of interest you pay in several ways:
- Pay your bill in full every month, if possible, to avoid interest.
- Make more than the minimum payment if you can’t pay your bill in full.
- Make payments more than once a month to shrink your average daily balance.
Now that you understand how it all works, you’re in a better position to take charge of your interest.
If you’re in the United States, read this article on the NerdWallet US site.
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