July 15, 2024

A Credit Card’s Interest Rate and How It Works

Credit card interest is a real thing if you’re the kind to carry a balance from month to month. Your top priority should be to prevent incurring that interest from the start. Otherwise, understanding the determination of this interest can help you better control the expenses associated with credit usage.

The rate of interest
The annual percentage rate (APR) is the standard form for credit card interest rates. Your account will apply this annual percentage rate to calculate the total interest you will pay on your average daily balance. The total amount you’ll pay in interest will increase in direct proportion to the APR.

Daily average balance
The majority of credit card companies calculate interest using the average daily balance approach. We factor in your total for the entire billing cycle.

As an illustration, consider a 30-day billing cycle in which you accrue a $1,000 balance for 15 days before paying off the balance to $500 for the remaining 15 days. After thirty days, your average daily balance would be $750, calculated as ($1,000 x 15 days + $500 x 15 days).

Interest calculations
The credit card company uses the following formula to calculate the actual interest you will pay:

The interest rate is equal to the annual percentage rate times the typical daily balance.

If you have an average daily balance of $750 and an annual percentage rate of 18%, you can calculate the following:

The interest for that billing cycle, calculated as (0.18 x 12) times $750, is $12.25.

Interest that is compounded
You wind up paying interest on interest over time due to the accumulation of unpaid interest from prior cycles, which is an expensive aspect. While it works well for your savings, it wreaks havoc on your debt. The simplest way to avoid this snowball effect is to pay off your credit card amounts as soon as possible.

The leeway given
Fortunately, knowing your card’s grace period will help you minimize interest fees. If you pay your statement balance in full each month within the grace period, you will not incur any interest on new purchases for that billing cycle. We calculate interest when you carry over a balance beyond the due date.

Credit card interest may add up quickly, so it’s important to know how to minimize it. One strategy is to pay off your bills as soon as possible and take advantage of interest-free grace periods.

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