How do credit cards calculate interest?

Although credit cards have an annual percentage rate for charging interest, each month when a cardholder does not pay their balance in full will lead to daily interest charges in the coming month. This makes it slightly more difficult for cardholders to calculate how much interest they are being charged for each day. Credit card debt can be expensive, so we suggest cardholders remain on top of their monthly payments, and if they do not, at least get a card with a relatively low APR to save on interest charges. 

In order to calculate the daily interest you will be charged, you first need to take the APR as given and divide it by how many days there are in a year. Many cards offer varying APRs depending on your creditworthiness, so make sure you double-check with the bank which APR you are being charged with. Once you divide the APR by 365, this will give you your periodic interest rate

The next step involves looking at your balance on each billing day throughout the year (there should be 12, one for each month). Add up these balances and divide them by the number of billing days to find the average daily balance.

Now that you have your periodic interest rate and average daily balance, all you have to do is multiply these two values together and then multiply this result by the number of billing days. 

Why credit interest is important to consider

It is important to note that credit card interest compounds daily for each day that you have not paid your balance in full. This means that you have to pay interest on your interest, making credit card debt very expensive. Many people are unaware of the extent to which credit card debt builds daily. By calculating how much interest you face on a daily basis, this is the first step in recognizing how many dollars are unnecessarily ripped from your pocket on interest alone. With this awareness comes an assortment of ways to reduce or eliminate these costs.

When interest rates are not applicable

The only instance in which interest on your balance does not apply is when you pay your credit balance in full monthly, it is that simple. This is the easiest and most efficient way to avoid all interest charges, by staying on top of your payments at all times. 

How to reduce credit interest costs

To many people, however, making all payments monthly is not a viable option. We recommend an assortment of ways to minimize these pesky and unnecessary interest fees. Cardholders might consider making payments to your balance more than once a month. Since interest is compounded and charged to you daily, making payments more than once a month will decrease your balance amount and therefore reduce the amount of interest you must pay.

Additionally, if you own a high-charging interest card and often do not fulfill your monthly payments, it could be extremely beneficial to consider switching to a card that charges a lower interest rate. This could allow you to save hundreds of dollars annually from lower interest costs alone. Many rewards cards tend to charge high-interest to their cardholders, so if you are looking to reduce the interest you are facing, consider switching to a non-rewards card.

Finally, since APR tends to vary depending on your creditworthiness, having a better credit score will result in lower interest charges. Increasing your credit score has the additional perk of allowing you to upgrade to even better credit cards, so this is a very helpful aspect to work on improving. One way to do this is by asking your bank for a lower credit limit. This is a useful way to remove the temptation to rack up a large credit balance and instead keeps the cardholder committed to only spending what they can afford.