It’s tempting to rack up a credit card balance. After all, you typically don’t need to make a payment for 21 days giving you some flexibility in your budget. And even after the grace period ends, you only need to make a minimum payment which represents only a portion of your entire balance.
Sounds like a good solution, right? Unfortunately, making this a habit can leave you racking up interest charges and a higher credit card balance than you may have anticipated. Keep reading to understand how credit card interest adds up, and to learn some tips that will help you manage credit card debt.
How to calculate credit card interest: 4 steps
1. Find out your credit card’s interest rate
The interest rate should be listed on the credit card documents you received at the time of applying for your credit card. If you can’t find your documents, or are unsure of what the interest rate is, contact your credit card provider.
But be careful – sometimes credit card purchases and cash advances have a different interest rate even for the same credit card. Be sure to ask so you have all the details you need to properly calculate your credit card interest.
Other important considerations:
- Ask your credit card provider if your interest rate is variable or fixed. If it’s variable, it could change at anytime.
- Note that if you applied for a credit card during a promotion, the interest rate can go up after the promotional period ends.
- Make sure you know the terms and conditions such as if your interest rate will go up if you miss a certain number of payments.
2. Learn the difference between your statement balance and outstanding balance (or current balance)
The balance displayed on your monthly credit card statement is your statement balance, and usually covers a 30-day period. It’s important to note that your statement balance might not start on the first day of the month. Most people find it easier to keep track of spending and to calculate their credit card interest when their statement balance starts on the first of the month. If your statement starts in the middle of the month, it may be worth asking your credit card provider if you can change it.
Your September statement includes all your purchases from September 1-30, and shows that you owe $ 1,000 – this number represents your statement balance. Any unpaid balance from a previous billing cycle will also be reflected in your statement balance. You’ll need to pay this amount by the deadline indicated on your credit card statement to avoid paying any interest.
Since receiving your credit card statement, you’ve spent an additional $ 300 on your credit card. Your outstanding balance is $ 1,300. However, you don’t have to worry about being charged interest on the additional $ 300 until your October statement.
3. Calculate your average daily balance
Typically, credit card interest is calculated using your average daily balance. The reason? Our credit card balance fluctuates everyday, so average daily balance is used to determine how much interest should be charged during a billing cycle.
Average daily balance can be a bit tricky to calculate since people typically use their credit cards almost everyday. But here’s a simple example to help you understand how your average daily balance is calculated.
Purchases made during your billing cycle:
Day 1: $ 500
Day 10: $ 1,000
Day 20: $ 500
To calculate the average daily balance, take each day’s balance and add them up. The calculation looks like this:
Day 1-9: ($ 500 x 9) = $ 4,500
Day 10-19: ($ 1,500 x 9) = $ 13,500
Day 20-30 ($ 2,000 x 10) = $ 20,000
After adding these up, our total is $ 38,000. Then, we divide this number by 30 (the number of days in a billing cycle) to find out our average daily balance, which in this example, is approximately $ 1,266.66.
Tip: It should always be your goal to pay off your statement balance every month. But if you’re not able to, making larger purchases near the end of your billing cycle can help reduce interest charges since it will lower your average daily balance.
4. Get your calculator out and do the math
Your interest rate and average daily balance is all you need to know to calculate your credit card interest. Once you have this information, follow these three steps:
- Step 1: Divide your interest rate by 365 (the number of days in a year)
- Step 2: Now that you have your daily interest rate, multiply it by 30 (the number of days in your billing cycle)
- Step 3: Next, take this monthly interest rate and multiply it by your average daily balance – the number you get is how much interest you’ll be charged for the billing cycle
Let’s continue with our above example at a 30% annual interest rate to demonstrate how this is done:
- Step 1: 30% / 365 = 0.00082
- Step 2: 0.00082 x 30 = 0.0246
- Step 3: 2.46% x $ 1,266.66 = $ 31.16
In this scenario, you’ll be charged $ 31.16 if you don’t pay your statement balance in full by the due date. It may not sound like a lot of money to pay, but the next time your bill rolls around you’ll have to pay $ 2,031.16. If you don’t pay subsequent bills, your interest will continue to compound on the new higher balance.