A credit card can be used as a valuable tool in times when you need to utilize extra cash to pay for an emergency or take advantage of a great deal. It’s important that you understand how to calculate credit card interest when you decide to use your credit card so that you can determine how much you are paying a bank if you decide to use their money.
Your Annual Percentage Rate
Whenever you make purchases using your credit card, you’re subject to the rate of interest that a bank is charging you to borrow from them. This is known as an APR or Annual Percentage Rate. While it’s listed as a yearly rate, your credit card company will use it to calculate the fee that you incur during each monthly billing period.
Calculating Daily Credit Card Interest
If you decide to keep an outstanding balance on your credit card and not pay off the full balance each month, you’ll start to accumulate an amount of interest that is added to your outstanding balance each day. While your APR is listed as a yearly amount, it can be broken up into days by dividing it by 365.
After each day has ended, your bank will take the current balance of your card and multiply that amount by the amount of daily interest that they charge. This process continues day by day until you completely pay off the full balance or a partial payment takes your account balance down to a lower number. If you make a partial payment, the bank will take the new amount that you owe and continue to charge you an amount of daily interest that’s added to your daily balance.
Example of Daily Interest
Let’s say you have a credit card that has an APR of 18 percent. To determine the daily rate of interest, you would divide 18 by 365. This gives you a daily interest rate of (18%/365 = .0493%) .0493 percent. If you have a current outstanding balance that is equal to $1000, you would owe an interest fee of ($1000 x .0493% = $0.49) $0.49 after the end of the first day. This fee is then added to your current balance and carried over to the next day.
The next day you begin with $1000.49. At the end of that day, you would incur another fee that would be equal to ($1000.49 x .0493% = $0.50) $0.50. Again, that amount would be added to your outstanding balance of $1000.49 to give you an account balance of $1000.99 for the next day. The process continues until the balance owed is zero.
The Effect of Compounding Interest
As you can see by the example, when you use a credit card and have an outstanding balance, the amount of interest that you pay compounds each day that the balance is left unpaid. When these type of charges accrue, you can actually end up paying a higher amount in interest payments then your APR. While you’d think that an 18 percent APR would only equal ($1000 x 18% = $180) $180 a year in fees. In actuality, it would be closer to $195 due to the effect of compounding interest.
Understanding how to calculate credit card interest gives you a good perspective of how much money you are actually paying your credit card company to lend you funds.