Understanding and Calculating Credit Card Interest
How Does Credit Card Interest Work?
Not sure where to start with the calculator above? Let’s take a look at four terms you’ll find in the fine print of your credit card statement and cardholder’s agreement:
- Annual Percentage Rate (APR) – The rate of interest a card is charged if it carries a balance for 12 months. A credit card usually has different APRs for different credit card uses, including Purchase APR, Balance Transfer APR and Cash Advance APR. The one cardholders are most familiar with is Purchase APR, which is the interest they pay on the purchases they charge to the card.
- Daily Periodic Rate (DPR) – The rate of interest a card is charged each day.
- Average Daily Balance (ADB) – A card’s average balance each day over the course of a month.
- Compounding – A previous day’s interest is added to the next day’s balance until the end of that month’s billing cycle. In the purchase agreement, cardholders are advised that interest compounds on a daily basis.
Now that we have a good grip on those concepts, let’s get into the nitty gritty: there are two ways credit card issuers calculate interest. In both calculation methods the credit card issuer converts your APR into your DPR and then calculates your daily balance (either an Average Daily Balance for the month or an approximate calculation of your balance each day). It then takes each day’s interest charge and adds it to the next day’s average balance so that the interest compounds until the end of the billing cycle. Your new balance is then posted minus any payments or credits.
Too fast? We’ll put the brakes on a bit and walk you through the process step by step.
How to Calculate Your Interest Payments Manually
First, find your DPR by dividing your APR by 365 or 360. For example, if your APR is 18.25% and your issuer divides that number by 365, your DPR rate would be 0.05%. You then find your average daily balance by adding each of your daily credit card balances for the month together and dividing that number by the number of days in your billing cycle.
Let’s make it easy and say your average daily balance is $1,000. To find the amount of interest owed after day one of that balance, simply take $1,000 and multiply it by 0.05%, giving you a first day interest charge of $0.50. On day two it gets a little more complicated because your new starting balance is $1000.50 and your issuer multiples that number by 0.05%, which gives you another $0.50 plus a fraction of a penny: a new balance of about $1,001. This process continues until the end of a 30-day billing cycle when you’d owe $15.11 in interest – assuming you didn’t make any new purchases or payments within that time.
Skip the Math and Go Automated in 3 Easy Steps
Some might be inclined to manually work through the math required to understand their card’s interest, but it’s much easier to automate the process. The GreedyRates credit card interest calculator also allows you to play around with different repayment timelines and average monthly contributions to see how it affects your total interest paid—while doing the same with pencil and paper would be quite tedious. Below are the simple steps you take when working with our calculator:
- Enter your card’s current balance
- Input the current interest rate (APR) you pay on this card balance
- Enter your estimated monthly payment amount or the number of months you’ll take to repay the debt
How Can I Save on Interest?
Paying too much in credit card interest can gradually eat away at your financial resources, throw off your budgeting and prevent you from reaching your financial goals. But there are ways you can reduce the amount of card interest you pay.
Pay Your Balance in Full and on Time
This one isn’t rocket science and it’s the number one way to avoid paying interest altogether. If you simply pay off what you’ve charged in its entirety by the due date, no amount will carry over into the next month and you won’t incur interest on an unpaid balance. Plus, those who consistently pay off their balances every month will have high credit scores, which will automatically qualify them for the best credit card offers out there. A high credit score will also make it easier to apply for a mortgage, a car loan, a line of credit or anything else you might need that requires a credit check.
Be particularly cautious with your spending on cards formally designated as ‘charge cards’ rather than credit cards (e.g. those issued by American Express). These cards have no grace period and the balance is due as soon as the statement is posted. Interest on these cards is typically higher than average as well.
Find a Card with a Better Interest Rate
There are a number of reasons you might carry a balance on a credit card from month to month:
- You need to make a big purchase and don’t want to drain your savings
- You have unexpected emergency expenses
- You want to divert your cash to other financial goals
Whatever the reason, most of us will carry a balance at one point or another in our lives, and having a credit card with a low purchase interest rate can save quite a bit of money on these occasions. Most Canadian credit cards charge a purchase interest rate of around 20%, but some cut that rate in half (or more).
Complete a Balance Transfer
Sometimes the best strategy for paying down your balance is finding a low-interest or even 0% balance transfer credit card and transferring your existing balance(s) onto it. Balance transfer promotions allow you to shelter a credit card balance from the high APRs that it may be currently exposed to. These transfers can reduce or entirely halt the interest charges that would have otherwise accrued at your old rate, enabling your regular monthly payments to contribute more to the principal balance.
Consolidate Debt with a Loan
A loan may be an effective debt consolidation tool and is helpful for those with many credit card balances at different rates. Instead of juggling them all and paying more for it, a loan with a lower interest rate compared to the average among your cards can be used to pay them all off simultaneously. Deploying your borrowed money in this way ultimately achieves two things: a single rate rather than many, and a lower average monthly payment.