Carrying a credit card in your wallet is a huge responsibility, especially since any balance you run up will need to be paid back. Unfortunately, you'll also have to pay credit card interest, which is a percentage charged on your average daily balance, on top of what you borrowed to begin with.
Obviously, credit card interest makes paying your balance off infinitely harder. Worse, figuring out how this interest is calculated isn't as easy as it seems.
But, if you want to use credit, you should really know how credit card interest – as well as additional fees – are levied. So, how is credit card interest calculated anyway? Let's dig in.
How Credit Card Interest is Calculated
If you don't pay your credit card balance in full each month, the balance you carry over is subject to interest based on your card's APR, or annual percentage rate. However, interest isn't actually calculated annually as the name would suggest; it's calculated daily. Here's how it's done:
To find a daily interest rate, card issuers take your APR and divide it by the number of days in the year – some using 365 and others using 360. Either way, this leaves credit cards with a DPR, or daily periodic rate they can charge on your balance every single day.
Credit Card Interest in Action
But, how exactly does it work from there? Let's say your credit card's APR is 15 percent and you can't quite pay the balance every month. To find your daily periodic rate, you'll want to divide that number by 365. When you do, you'll come up with a DPR (daily periodic rate) of 0.041 percent.
To find out how that percentage translates into credit card interest, you'll want to figure out your average daily balance, too. This number can be reached by taking the amount you owe each day of the month and multiplying by the number of days you spent with that balance, then dividing the total for the month with the number of days.
Example: If you owe $500 on your credit card at the beginning of the month and charge another $1,000 on your card on the 15th, your average daily balance for the month will be $1,000. ($500 * 15 days) + ($1,500 * 15 days) = $30,000/30 days = $1,000
Once you find your average daily balance, you'll want to take that figure and multiply it by your daily periodic rate, then multiply it again by the number of days in your billing cycle. At the end of the day, you'll be charged around $12.30 in interest per month using this scenario. $1,000 * 0.00041 * 30 days = $12.30
Why Your Card's APR Matters
While the scenario outlined above is outwardly confusing, there's one big takeaway that shouldn't be overlooked. How much money you pay in interest – or your credit card's APR – matters a lot more than you think. After all, running the same scenario above with a 5 percent APR will result in a monthly interest charge of just $3.90 – or around 60 percent less. As I'm sure you can imagine, this scenario can play out in a number of ways, with bigger stakes as the amount of money you borrow grows. And if you're not careful, you could end up paying hundreds of dollars in interest every single month.
Fortunately, LendingTree offers a slew of low interest credit cards– and even 0% introductory offers – for those who qualify. If you want to save money on credit card interest, a low interest card or an attractive balance transfer offer is a good place to start.
Or, you could save on interest the old-fashioned way. If you use credit frequently, get into the habit of paying your balance in full each month. As always, that's the best way to avoid paying credit card interest – and the only way to stay out of debt.