Getting your first credit card is super-exciting. Hello, independence! Unfortunately, though, lots of first-time credit card owners don’t know enough about credit card interest. And then it’s hello, long-term debt.
Don’t let this be you! Here’s all you need to know about credit card interest and how it works:
What is credit card interest?
Credit card interest is the money the credit card issuer charges cardholders to borrow money when they use their cards. The interest is generally set at an annual rate known as the annual percentage rate, or the APR.
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Important credit card terms to know
- A credit card billing cycle is the period of time between credit card billings. During that time, any purchases, credits and interest charges will be added to or subtracted from your balance.
- When the billing cycle ends, you’ll receive your credit card statement, which will reflect all unpaid charges and fees for this time.
- The statement will also highlight the payment due date, which tends to be approximately 20 days after the end of the billing cycle.
- The time frame between the end of the billing cycle and the payment due date is known as the grace period.
Calculating interest
To calculate your interest charge for a billing cycle, follow this formula:
Step 1: Divide your APR by the number of days in a year to get your daily periodic rate, or the amount of interest your credit card issuer charges during each day of the billing cycle.
If your APR is 18.5%, you’ll divide it by 365 to get your daily periodic rate of .0005%. (0.185 / 365 = .0005)
Step 2: Multiply the daily periodic rate by your average daily balance, or the balance you carry during each day of your credit card’s billing cycle to get your daily interest charge.
Using the above example, if your average daily balance is $1,200, multiply this number by your daily periodic rate (.0005%) to get a daily interest charge of $0.60. (0.0005 * 1,200 = 0.60)
Step 3: Multiply your daily interest charge by the number of days in your billing cycle.
To follow the above example, if your billing cycle is 30 days, multiply $0.60 by 30 to get an interest charge of $18 for this billing cycle. (0.60 * 30 = 18)
Avoid paying interest
Credit card issuers will only charge interest if you carry a balance from one month to the next. If you pay your balance in full before the grace period ends, there will be no interest charged at all. Set yourself a reminder to pay your bill before it’s due and you’ll never pay credit card interest again. Sweet!
Credit cards are a necessary part of life, but they can also be a gateway to debt. Before applying for that precious piece of plastic, brush up on your knowledge of how credit card interest works and how it affects you as a cardholder.
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