Do you ever look at your credit card bill and think what type of math did this credit card company do to calculate this interest? Well, we do as well sometimes! Let’s hope that we never have to accrue credit card interest as it is some of the highest cost of borrowing money, however, if you have accrued credit card interest, let’s simplify the calculation so that you can understand it!
What is Credit Card interest?
Interest is the cost of borrowing money. Simply put, if you cannot pay the credit card company back for the money you spent using the credit card, they charge you a cost of borrowing the money. Credit Card Interest rates are some of the highest out there at around 19.99-24.99%. The best financial action would be to avoid paying interest when using credit cards by paying your bill in full each month. This will not only help you save money but also improve your credit score.
The Calculation Breakdown
Here’s a breakdown of how to calculate your credit card interest in simple steps. Grab your bill statement and follow along to understand the calculation.
Step 1 – Calculate the annual interest rate to daily rate
The interest rate identified is usually presented as an annual interest rate, thus the 19.99% is an annual rate. We must convert this to a daily rate by dividing it by 365 days.
For example, an annual rate of 19.99% divided by 365 is 0.0547%.
The bank can vary on the number of days used due to a leap year or a base number of days. This number should not make a significant difference but it is important to know.
Step 2 – Determine your Average Daily Balance
This is the hardest part of the calculation and does require a spreadsheet. In order to arrive at the right interest calculation, the credit card companies use the average daily balance on your credit card. The average daily balance is the amount of credit you have used averaged across the number of days in your billing cycle. If you purchase something using your credit card, you increase the amount of credit and if you make a payment, you reduce the credit.
For this step, open a spreadsheet and list out the days in your billing cycle in one row. Under each day, write your daily balance. Thus if you spent $50 on day 1 and made a payment of $10, your daily balance on day 1 is $40. Once you’ve done this for all the days in your billing cycle, add them up and divide the sum by the number of days. The number calculated is your average daily balance.
Pro Tip: Your billing cycle is usually the day that you receive your bill each month. It can vary due to holidays or weekends but is usually consistent to a certain day. If you are unsure, you can always call your credit card company to confirm.
Step 3 – Final Step of Multiplying
Now if you have the spreadsheet going, this final calculation will be easy. Multiply the daily rate by your average daily balance and then multiply that by the number of days in your billing cycle.
If you are noticing a difference in the amount you calculated versus the one on your bill statement, remember that credit card interest is also compounded.
If you read through this simplification and still feel uneasy, we understand! If this is not your forte and you would like some assistance, do not be afraid to call your credit card company and ask for a breakdown of your credit card interest calculation. You will be able to talk to someone and have them walk you through their calculations.
We highly suggest doing the calculations on your own in order to dispute wrong charges! Use your credit card responsibly and avoid the interest charges by paying in full each month.
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