The Basics: Credit Card Interest

Step #1
The first step in calculating credit card interest is to find the Annual Percentage Rate (APR) of the card. This rate is set by the bank that issued the credit card and can be affected by a variety of factors, including your credit score, promotional periods, the prime interest rate (the rate banks charge large corporations for borrowing money), and your payment history. Due to the many factors involved, APRs can range anywhere from 0% all the way to 80% or more.

You can find the APR by looking at your last statement or by contacting the bank that issued the card.

Step #2
Convert your APR into a daily interest rate by dividing it by 365 (the number of days in a year). This will give you the interest rate that your bank charges each day that you hold a balance. That’s right, credit card interest isn’t actually charged annually, instead a small amount is charged every day.

Step #3
Calculate the average daily balance of the billing cycle by adding up each day’s balance and then dividing by the number of days in the billing cycle.

Step #4
Multiply the average daily balance by the daily interest rate to calculate the average daily interest amount.

Step #5
Multiply the average daily interest amount by the number of days in the billing cycle to get the interest owed for the period.

That’s it!

Note: You may find that the interest you owe on your credit card debt is slightly higher than what you’ve calculated. This is most likely due to the method of compounding your credit card issuer uses. Many issuers compound monthly or even daily. As a result, not only will you owe interest on the money you have spent, you'll also owe interest on the interest from the previous month (or day). This has the potential to greatly increase the amount you owe over time. Just as compound growth can quickly grow your investments, it can also quickly grow your debts.

Using the following assumptions, here’s how we would calculate the interest.

Assumptions
APR = 17.5%
Billing Cycle = 30 Days
Average Daily Balance = $1,000

Daily Interest Rate = 17.5% / 365 = 0.0479%

Average Daily Interest Amount = $1,000 x 0.0479% = $0.48

Interest Owed = $0.48 x 30 days = $14.40

There is some good news in all of this. It is possible to take advantage of all the benefits of a credit card and still avoid the expensive interest payments. Credit card issuers provide a grace period during each billing cycle. All you have to do is pay off the statement balance of the card before the end of the billing cycle. If you do this, no matter what your average daily balance or daily interest rate is, you will be charged exactly $0 in interest! If you don’t pay off the statement balance in full you will most likely be charged the full amount of interest for the entire period.

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