Understanding and Calculating Credit Card Interest
If you use a credit card, you pay interest on that card for every month you carry a balance. Your interest payments may start out small, but the longer you take to pay your balance off in full, the more the interest compounds. The interest incurred can grow every month until your monthly payment balloons into an unrecognizably massive figure.
Sometimes even when you think you’re paying your principle balance, you’re really only paying off the interest itself, which returns every month. This can put you on a frustrating treadmill of never seeing the balance go down. Interest can be confusing too, because even though the credit card company will advertise your Annual Prime Rate (APR) of interest, they charge the interest monthly, not annually.
If you’d like to figure out credit card interest once and for all, read this guide and check out our own credit card interest calculator.
How Does Credit Card Interest Work?
Let’s start by getting familiar with four terms you’ll find in the fine print of your credit card statement and cardholder’s agreement:
- Annual Percentage Rate (APR) – The rate of interest a card is charged if it carries a balance for 12 months. A credit card usually has different APRs for different credit card uses, including Purchase APR, Balance Transfer APR and Cash Advance APR. The one cardholders are most familiar with is Purchase APR, which is the interest they pay on the purchases they charge to the card.
- Daily Periodic Rate (DPR) – The rate of interest a card is charged each day.
- Average Daily Balance (ADB) – A card’s average balance each day over the course of a month.
- Compounding – A previous day’s interest is added to the next day’s balance until the end of that month’s billing cycle. In the purchase agreement, cardholders are advised that interest compounds on a daily basis.
Now that we have a good grip on those concepts, let’s get into the nitty gritty: there are two ways credit card issuers calculate interest. In both calculation methods the credit card issuer converts your APR into your DPR and then calculates your daily balance (either an Average Daily Balance for the month or an approximate calculation of your balance each day). It then takes each day’s interest charge and adds it to the next day’s average balance so that the interest compounds until the end of the billing cycle. Your new balance is then posted minus any payments or credits.
Too fast? We’ll put the brakes on a bit and walk you through the process step by step.
How to Calculate Your Interest Payments Manually
First, find your DPR by dividing your APR by 365 or 360. For example, if your APR is 18.25% and your issuer divides that number by 365, your DPR rate would be 0.05%. You then find your average daily balance by adding each of your daily credit card balances for the month together and dividing that number by the number of days in your billing cycle.
Let’s make it easy and say your average daily balance is $1,000. To find the amount of interest owed after day one of that balance, simply take $1,000 and multiply it by 0.05%, giving you a first day interest charge of $0.50. On day two it gets a little more complicated because your new starting balance is $1000.50 and your issuer multiples that number by 0.05%, which gives you another $0.50 plus a fraction of a penny: a new balance of about $1,001. This process continues until the end of a 30-day billing cycle when you’d owe $15.11 in interest – assuming you didn’t make any new purchases or payments within that time.
Skip the Math and Go Automated
Unless you’re one of those rare creatures that loves math and manual calculations, you might prefer to automate this cumbersome process. GreedyRates’ Credit Card Interest Calculator allows you to simply plug in some basic numbers before telling you the amount of interest you can expect to pay until your balance is fully paid off. Navigate to our interest rate savings calculator and input the following information:
- Your credit card’s approximate current balance
- Your card’s current interest rate (APR)
- Your projected monthly payment, either as a percentage or a dollar value
After inputting that information and clicking the orange ‘Recalculate’ button at the bottom, a table of recommended credit cards will pop up to the right. Under each of the recommended cards you can click ‘Show offer details’ and then ‘How did we calculate this?’ to see the following:
- The amount of interest you’ll pay with your current card until the balance is paid off
- The amount of interest you’ll pay with the low-interest credit card we recommend
How Can I Save on Interest?
Paying too much in credit card interest can gradually eat away at your financial resources, throw off your budgeting and prevent you from reaching your financial goals. But there are ways you can reduce the amount of card interest you pay.
Pay Your Balance in Full and on Time
This one isn’t rocket science and it’s the number one way to avoid paying interest altogether. If you simply pay off what you’ve charged in its entirety by the due date, no amount will carry over into the next month and you won’t incur interest on an unpaid balance. Plus, those who consistently pay off their balances every month will have high credit scores, which will automatically qualify them for the best credit card offers out there. A high credit score will also make it easier to apply for a mortgage, a car loan, a line of credit or anything else you might need that requires a credit check.
Be particularly cautious with your spending on cards formally designated as ‘charge cards’ rather than credit cards (e.g. those issued by American Express). These cards have no grace period and the balance is due as soon as the statement is posted. Interest on these cards is typically higher than average as well.
Find a Card with a Better Interest Rate
There are a number of reasons you might carry a balance on a credit card from month to month:
- You need to make a big purchase and don’t want to drain your savings
- You have unexpected emergency expenses
- You want to divert your cash to other financial goals
Whatever the reason, most of us will carry a balance at one point or another in our lives, and having a credit card with a low purchase interest rate can save quite a bit of money on these occasions. Most Canadian credit cards charge a purchase interest rate of around 20%, but some cut that rate in half (or more).
Complete a Balance Transfer
Sometimes the best strategy for paying down your balance is finding a low-interest or even 0% APR promotional rate and transferring your existing balance to that credit card, so you can pay off your balance at the lowest possible interest rate. Be warned though, as noted earlier, a different APR is applied to balance transfers and it may be higher than a credit card’s purchase APR.
If you’re looking for a great balance transfer card that carries low interest on balance transfers, GreedyRates offers both a Balance Transfer Interest Savings Calculator and a Low Interest Savings Calculator, similar to the calculator we covered earlier.
Consolidate Debt with a Loan
The last option for making it easier to pay off the balance of your credit cards is to apply for a loan with a lower interest rate than the rate (or rates) charged on your credit cards. You can use a low-interest loan to immediately pay off the balances on your cards and pay less interest in the long run. We strongly suggest you to compare loans in Canada and gain more information.