How is credit card interest calculated?

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The goal for most cardholders is to pay their credit card balance in full every month so they won’t be charged a penny of interest. Of course, there are many people who can’t do this. According to one survey, approximately 45.4 percent of American families have credit card debt. 

Whether you try to always pay off your credit card completely or you carry a balance from month to month, you should understand how your credit card interest is calculated and how it works. We’re here to break it down for you so you know where you stand with your credit cards. 

What is credit card interest?

Credit card interest is the money you’ll be charged if you don’t pay your credit card balance in full by the monthly deadline. Essentially, credit card interest is the cost of borrowing money from the card lender. 

Your credit card interest rate is expressed through an annual percentage rate (APR), which is the yearly interest charged on a loan or credit card. You can find your credit card’s APR within the terms and conditions of the credit card contract and on your monthly statement.

You aren’t charged interest from the moment you make a purchase on your credit card—instead, you have a grace period. You have from the end of your billing period to the payment due date to pay any charges on your statement without incurring interest. If you miss this deadline, interest will start to accumulate and will continue to do so until you pay off the amount in question entirely. 

Note that some cards have an introductory or promotional APR. In this case, you may get an offer, like 0 percent APR, for the first six months you have the card. After this, the card will begin having a standard rate. Again, you can find all these details in your credit card terms and conditions and also in your monthly statement. 

According to data, Americans’ average credit card interest rate was 16.13 in January 2022. Of course, this was just an average. Your credit card APR can vary significantly depending on the type of card you have, your credit history and other factors. 

Variable rate vs. fixed rate

Most credit cards have a variable interest rate, but a few fixed options are also available. Variable rates change based on federal rate fluctuations. This means your rate won’t necessarily stay at the rate you had when you initially signed up for the card. However, the good news is that you shouldn’t be too surprised by rate changes. Thanks to the 2009 Credit CARD Act, lenders have to give borrowers advance notice before issuing a rate increase. 

The Credit CARD Act was passed by the U.S. Congress and signed into legislation by President Barack Obama. The intent of the act is to help “establish fair and transparent practices relating to the extension of credit.” One of the many changes made by the act was that lenders have to give written notice of an increase to an APR at least 45 days before the change comes into effect. 

A fixed rate is much less common for credit cards but does exist. A fixed rate (also known as a non-variable rate) will usually remain unchanged, which some people prefer because it offers consistency and is easier to plan around. However, there are some instances when even a fixed rate can change. For example, many credit cards stipulate that a missed payment results in an increase in the fixed rate. 

Penalty APRs

Penalty APRs are just what they sound like—a higher APR that kicks in as a penalty, usually when you’ve missed a payment by at least 60 days. Some penalty APRs can be as high as 22.99 percent, but the exact amount will depend on your card’s contract. 

Once a penalty APR kicks in, it can apply to all current and future charges. In fact, a penalty APR can override an introductory offer, like the ones we covered earlier. 

After approximately six months of on-time payments, most cards will revert from the penalty APR to the original APR. 

How your credit card interest is calculated

Since your given interest rate is annual but you’re billed monthly, card issuers use the APR to calculate how much you should be billed each month. And this amount doesn’t have to remain a mystery to you. Just follow these simple steps to determine how your credit card interest is calculated: 

1. Determine your daily rate

Take your APR and divide it by 365 for each day of the year. So, if your credit card APR is 18.25 percent, your daily rate will be 0.05 percent, which in decimal form is 0.0005.

2. Determine your average daily balance

Go through all the transactions in your billing period, day by day, and add up each day’s balance. Don’t forget to add the balance that carried over from your previous billing cycle and subtract any payments made during the current cycle as applicable. Then divide the total by the number of days in the billing period to get your average daily balance. 

For example, if you had a balance of $0.00 for 10 days, then $500.00 a day for 10 days, then $1,000.00 a day for the last 10 days of the month, you would add all of those numbers up to get $15,000. Divide that by 30 days, and your average daily balance would be $500.

3. Multiply to determine your daily interest charge

The last step is to multiply your daily rate by the average daily balance. You then take that number and multiply it by the number of days in your billing cycle. 

So, in the above examples, you would take 0.0005 and multiply it by $500 to get $0.25. Next, you would multiple $0.25 by your billing cycle of 30 days. Your interest for the month would be $7.50. 

This number might sound small, but over time you will have to pay more and more in interest if you don’t fully pay off your balances.

How to pay less in credit card interest

Here are four ways to either reduce or avoid any interest charges on your credit cards:

1. Pay your balance in full

The most obvious step is to always pay your balance in full. However, if you can’t do this, it’s essential to at least make the minimum payment. Making the minimum payment will ensure you don’t get a negative mark on your credit report for missed payments and help you prevent a penalty APR from kicking in. 

2. Make payments more often

You don’t have to wait until the end of your billing cycle to make a credit card payment. Making payments more frequently will help you lower your average daily rate and subsequently lower your interest charges if you carry a balance. 

3. Use a balance transfer card

A balance transfer card typically gives you an introductory APR that’s low (often as low as 0 percent). The introductory APR will only last a few months, so you have to make sure you take advantage of it and pay off all your credit card debt, or as much of it as you can, to make it worth it. 

Additionally, be aware that balance transfer cards usually come with a one-time fee that’s a percentage of your balance. You’ll want to consider this cost when evaluating if the balance transfer is the best financial decision. 

4. Improve your credit

Typically, higher credit scores are associated with more favorable credit card terms and offers. So if your credit score increases, you might be able to get a new card with a lower APR, or you could potentially even ask your card provider if they’d be willing to decrease your current card’s APR.

Use credit wisely

If you use it responsibly, you can use a credit card for purchases, gain rewards or cash back and never pay any interest. However, poor credit card habits can cost you a lot in interest and even negatively impact your credit score. 

If you have a low credit score due to previous financial mistakes, you can rebuild your credit. The credit repair consultants at Lexington Law Firm have helped thousands of people review their credit, file disputes and see an improvement, so reach out to our team today to see how we can help you.

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