How is Credit Card Interest Calculated?
6 MINUTE READ
2019 marked the first time the Federal Reserve slashed interest rates since the 2008 housing and financial crisis.1
You might be thinking to yourself, Yeah, I heard, but what’s that got to do with me? Interest rates tell banks or lenders how much money they can charge consumers for loans on things like cars and first homes. But Americans don’t just borrow for big-ticket items anymore, and statistics show the rate at which credit card balances become delinquent has been rising steadily.2 That means borrowers can expect to pay interest. But how much interest? Well, it depends.
Let’s start by defining some terms.
What Is Credit Card Interest?
Credit card interest can be boiled down to these three letters: APR. That stands for annual percentage rate. APR is simply the annual rate charged to you for borrowing money.
Some credit card companies and banks give you a grace period—that small sliver of time between when your billing cycle ends and when a minimum payment on your balance is due. You can pay off your balance in full without the penalty of interest. But more than half of all Americans who have a credit card fail to pay off their balance by the end of each grace period and let that monthly balance carry over to the next month.3
More than 5 million have beaten debt this way. You can too!
What's that mean in terms of interest? Well, believe it or not, APR applies monthly—not annually—to a credit card balance. That means if you don’t pay off your credit card bill by the end of your billing cycle, interest will be tacked on since that money is still technically on loan to you.
Bottom line: Interest is money that’s charged just for the act of borrowing. No, thank you!
What’s the Average Credit Card Interest Rate?
You may be surprised to find that APRs on credit cards can inch all the way up to 23.94%.4 That’s no small amount. Depending on how much of a balance you carry on your account, that could add up to . . . a lot. Even just $100 left unpaid each month could result in an extra $25 you owe by the end of the year—and people carry way more than just a Benjamin Franklin on their statements.
According to the Federal Reserve, the average credit card APR for the second quarter of 2019 was 17.14%.5 This follows a trend that shows average interest rates creeping higher and higher since falling just under 13.19% back in 2014.6
Of course, rates are set and maintained many different ways depending on the lender. So, if you have a credit card right now, the interest rate may be higher or lower than the average APR nationwide. Many households in the U.S. carry credit card debt. And if you live in one of them, expect your interest rate to tick up over time—guaranteed.
How to Calculate Credit Card Interest
To see how this really works, it’s time to dust off that old algebra textbook, sharpen those pencils, and do a little math. No, you don’t have to be an accountant to do these calculations, but beware—division and multiplication lie ahead!
1. Identify your APR.
For the sake of simplicity, let’s begin by knocking that average credit card APR down to just 15% and convert it to a decimal: 0.15. See? We’re going easy on you.
2. Convert APR to a daily interest rate.
Next, we’re going to divide that number by 365—the number of days in a year. So, 0.15 divided by 365 is 0.00041096. That’s a pretty small number! But unfortunately, it’s not the one we’re looking for. That number represents the daily interest rate.
3. Determine your account balance.
Let's figure that, for the purposes of this example, you just purchased a new living room set on credit and paid $2,100. That's your account balance. Easy enough.
4. Calculate how much you’re paying in dollars.
Lastly, we’re going to take the daily interest rate you figured out in step two and multiply that number by the account balance. Now, you have the amount of interest—in dollars—your account will increase by in one single day, month and year:
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$2,100 multiplied by 0.00041096 equals 86 cents for each day.
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Over the course of a 30-day month, that number adds up to $26.75.
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And throughout the course of a year due to compounding interest, it balloons to about $432.66.
When the math is broken down like this, we see exactly how much your interest is costing you in dollars and not percentage points—and not just annually, but monthly, which is where those billing cycles will hit you where it hurts.
Don't be deceived by that final number, though. The amount of interest can range widely depending on annual fees, late payments, etc. Also, keep in mind that if you stop making payments for any reason at all, that interest each month adds up to a larger account balance, which means more interest—and the vicious cycle continues . . .
How to Avoid Credit Card Interest
Okay. Now that you’re equipped with the knowledge of what credit card interest is and how it works, you’re probably wondering what's the best way to avoid interest, or even better—ditch it for good.
Here’s the deal: You don’t want to pay interest on anything because that’s money you’re forking over for the “privilege” of borrowing. We recommend saving up cash to pay for things and not borrowing in the first place.
But if you already took out a loan for that new couch, home entertainment system, or set of wheels, the smartest way to attack your debt is with the debt snowball method. And the good news is, the debt snowball involves very little math. In fact, this is the only math you need to know: Personal finance is 80% behavior and 20% head knowledge. And the debt snowball method helps you with that behavior change!
Here’s how it works:
Step 1: List your debts smallest to largest, regardless of interest rate. Pay minimum payments on everything but the little one.
Step 2: Attack the smallest debt with a vengeance. Once that debt is gone, take that payment (and any extra money you can squeeze out of the budget) and apply it to the second-smallest debt while continuing to make minimum payments on the rest.
Step 3: Once that debt is gone, take its payment, and apply it to the next-smallest debt. The more you pay off, the more your freed-up money grows and gets thrown onto the next debt—like a snowball rolling downhill.
The debt snowball method works because the person doing it gains momentum as they go, feeling motivated once they pay off the smallest debt and so on.
And listen up: The faster you work on your debt snowball, the sooner those credit card payments—and that interest—will stop cramping your monthly budget.