How is credit card interest calculated?

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Do you think that credit card interest is quite painful and hurting? Then, it is better that you should know how the interest on credit cards is calculated. 

Paying interest on credit cards is obviously very taxing for cardholders. And, what’s bad than this is the whole procedure of how is credit card interest calculated is quite complex and rife. Moreover, it is not fixed and can change with time or according to the terms of different credit card issuers. 

However, still you must know how is credit card interest calculated and what goes into it, especially if you tend to carry a balance on your card. Also, knowing the process of determining interest will help you to know how much interest you have to pay at the end of the month. 

How is credit card interest calculated?

When your credit card statement comes, the most important thing that you focus on is the APR or Annual Percentage Rate of your credit card. For most of the people, the Annual Percentage Rate of their credit card falls between 12.99 per cent and 29.99 per cent. This percentage is also known as the nominal rate. This rate of interest is a straight forward and simple way of calculating the interest that you must pay overtime on your credit card. However, it is not the best way of doing so. 

Image courtesy: Low Interest Credit Card
Image courtesy: Low Interest Credit Card

This is because as you may assume by its name, credit cards do not charge interest on your card account yearly. But, they charge it on a daily basis. Yes, you heard it right! Credit card interests are charged on an everyday basis on your account. And, this daily interest is calculated with the help of the DPR or Daily Periodic Rate of your credit card. This DPR can be determined after dividing your card’s APR by the total number of days in a year. However, in this also there are some banks or card issuers that divide the APR by 365 and some divide it by 360. 

Also, credit card issuers that charge interest rates on the basis of your DPR, they determine your owed amount by calculating your average daily balance. This average daily balance is calculated because the balance on your credit card can usually fluctuate throughout the month as you make more purchases and partial payments. 

Now, let us calculate your credit card interest by following a simple example. The first step in how is credit card interest calculated is to determine your average daily balance. For instance, we can say that you have a balance of $1000 in a 30 day period, which is carried over from the last month to the new month. Also, for this you do not use your credit card in any way in the following month. However, on the 11th day of the month, you pay $300 through your credit card. 

Image courtesy: InvestingAnswers
Image courtesy: InvestingAnswers

Therefore, the balance for 1 to 10 days will be $1000 and the subsequent balance for 11 to 30 days will be $700. Now, you have to add the total daily balance of this month and then divide this number by the total number of days in the period, so that you can get your average daily balance. This is (10 x 1,000) + (20 x 700) = 24,000 24000 / 30 = 800. 

Now, you must calculate your Daily Periodic Rate, which is the second step in this process. For instance, if your APR is 14 per cent, then you must divide it by 365. This means 0.14 / 365 = 0.00038. The daily periodic interest rate of your credit card is 0.038 per cent. Now, you must multiply the DPR by your average daily balance. After this, you need to multiply that number by the total number of days that are there in the period. This means 800 x 0.00038 = 0.304, which is then 0.304 x 30 = 9.12. Thus, you have to pay $9.12 as your interest charge for that month. 

Important points to keep in mind

Through this, you know how is credit card interest calculated. Now, you must keep two things in mind regarding your interest card interest. These things are: 

Image courtesy: Pixabay
Image courtesy: Pixabay

 

  1. The interest rate on a credit card is charged from the date you make your purchase. In reality it is not charged from the starting of the following month, as is mistakenly believed by many people. You do not get any grace period till you pay off your entire balance at the period end. In such a case, your interest charges will be waived.
  1. According to the CARD Act of 2009, the credit card statements clearly indicate in one of their sections the time period that you will take, if you pay only the minimum balance of your credit card every month. And, if you are the type of person who pays only the minimum balance every month, then paying attention to this section can prove to be beneficial for you, as you can make plans as to within how much time you can pay off your entire balance.

And, if you want to pay low interest rates on your credit card, then you must purchase a credit card that has a low APR. You can find the low interest credit cards on our website under the Low Interest Credit Cards section. You can also look under the Balance Transfer Credit Cards for cards that charge low interests on balance transfers and thus help you to pay off the debt on your credit card faster through debt consolidation.

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