- Calculating interest on your credit card allows you to see exactly how much you’re spending in interest each month.
- The snowball effect of compound interest means you could be paying significantly more in credit card interest than you realize.
- Knowing how much you’re spending in interest will help you take control of your finances and avoid paying interest moving forward.
Credit cards can be wonderful tools. They allow you to make major purchases that might otherwise be cost-prohibitive, shop online, travel without carrying around cash, and even help increase your credit score when managed responsibly. Knowing what credit costs you and how credit card companies calculate interest on your credit cards is an important part of successfully managing your finances.
We will show you how to calculate interest, as doing so will allow you to know exactly how much you’re paying in interest each month.
How Can I Calculate My Credit Card’s Interest Rate?
Whether or not you carry a balance on your credit card each month, it’s crucial to know what your credit card’s interest rate is. After all, you could be paying hundreds of dollars in interest each month without even realizing it, as most credit cards have very high annual percentage rates, or APRs.
Your credit card’s annual interest rate can typically be found toward the end of your bill under the section that says “interest charged.” There might be a “(v)” after the number — this means you have a variable interest rate. Most credit cards have variable interest rates, meaning they can change. Other loan types, such as mortgages and student loans, have fixed interest rates, meaning they stay the same.
Credit card interest isn’t as simple as it seems. Let’s say you have an interest rate of 17.5% on your credit card. You aren’t simply charged that rate each week, each month, or each year. That annual interest rate is instead converted into a daily interest rate, which is applied to your balance each day.
It works like this: You take your annual interest rate and convert it into a daily interest rate, which allows you to figure out the total amount of interest you’re paying. Let’s say your APR is 17.5%. To figure out your daily rate, you’d divide that number by 365 and get 0.0479%. Next, you’ll want to figure out your average daily balance. This can be done by looking at your most recent credit card statement, adding up every daily balance, and dividing the number by the total days in that billing cycle (usually about 30 days or a month, but not necessarily falling neatly on the beginning or end of the month; check your credit card agreement for specifics).
For example, let’s say your average daily balance for June was $1,000. You’d multiply $1,000 by 0.0479%, your daily rate, and then multiply that result by 30, the number of days in the month. The result is $14.37. This is how much you will be charged in interest that month.
Why Is It Important to Pay My Credit Card Balance Each Month?
When it comes to credit card interest rates, the most important thing to understand is the snowball effect of compound interest. After all, you could be paying quite a bit of money in monthly interest without even realizing it.
Let’s say you start with an unpaid credit card balance of $1,000. Each day, a daily interest rate will be added to your unpaid balance, of about 48 cents on the first day using our 17.5% example above. On day two, your balance increases to $1,00.48. In a week’s time, that daily balance grows to $1,003.36 and by the end of the month, it will be $1,014.48. Each day your balance goes unpaid, the interest rate will be charged based upon the previous day’s balance which includes interest growing for each passing day.
This means your average daily balance, the compounding interest charges, and monthly payment will continue growing, much like a snowball will grow as more and more snow is added to it. Before you know it, you could be paying an immense amount of interest each month.
This snowball effect is how so many Americans find themselves in credit card debt they can’t escape from. In fact, Americans paid credit card companies $113 billion in interest and fees in 2018 alone, a number that is expected to reach $122 billion in 2019.
Credit card companies would prefer you don’t pay your balances — it’s how they make their money. Think about it like this: Americans have a whopping $1.04 trillion in credit card debt, according to the Federal Reserve. All of the interest paid on this debt goes directly to the credit card companies in the form of a profit.
It’s also important to know that there are different types of interest charges on credit cards. In addition to your annual percentage rate, there are other types of interest rates, such as:
- An introductory APR: A lower APR when you open the card but increases after the introductory period ends.
- A balance transfer APR: The rate applied to an existing balance transferred to the new credit card.
- A penalty APR: A rate applied if you’re significantly late on payments.
- A cash advance APR: An interest rate applied to cash advances, typically higher than the rate for purchases.
By understanding how to calculate interest, paying off your balance in full each month, and making extra payments when you can, you score a win against credit card companies as a smart consumer.
How Can I Find a Credit Card With a Low Interest Rate?
Smart consumers also shop around. If you’re interested in opening a new credit card — perhaps even your first credit card — it’s important to do your research, as selecting the right credit card can make the difference between thriving financially and struggling to make payments. After all, if you select a card with a super-high interest rate, you could be hit with enormous fees in the event that you cannot pay your balance.
When selecting a new credit card to open, you should always take into consideration a credit card’s interest rate (usually listed as a range), annual fees, APR, penalties, transaction fees, and overall reputation.
Once you’ve decided that you’d like to open a new card, compare interest rates across a handful of cards — say four or five. This will help you ensure you’re selecting the one with the lowest interest rate.
Try to avoid being lured by special card offers and advertising. Be conscious of the marketing efforts associated with the credit card, and exercise critical thinking. Do you really want this credit card? How does it fit in with your financial plans? Is the interest rate reasonable?
Remember: At the end of the day, the best credit card is the one you can pay off each month.
Confident and Well-Informed
Now that you know about credit card interest and how best to avoid racking up those charges, you’re one step closer to the financial picture you’ve dreamed of. A picture that includes credit cards that work well for you, balances that are paid in full each month, and a stellar credit score as a result. You’ll feel confident knowing you’re paying only what you owe, avoiding the costly burden of credit card interest altogether.