Wednesday, 1 May 2019

How The Credit Cards Interest Are Calculated

How The Credit Cards Interest Are Calculated

For those of you that carry a balance on your credit card, you might be interested in how they actually calculate the interest on your credit card, in understanding how they actually calculate this you may be able to exploit this fact and be able to somehow pay less interest

Let's look at how they actually calculate this 

Credit card works on the things called an average daily balance, they check out what your average daily balance for that statement period is and then they calculate how much interest you owe for that statement period

Read: 5 Secret To Get Out Of Credit Card Debt

A point of confusion is that they don't actually do compounded interest as you go throughout the month, they actually just tally it up at the end of the month only 

How To Calculate Credit Card Interest

  • Day 1 - 15 = $100
  • Day 15 - 30  = $100 + $100 = $200
  • $100 x 15 + $200 x 15 divided by 30 = $150
  • 15% APR / 365 = 0.041%
  • 0.041% x = 1.233%
  • $150 x 1.233% = $1.85 interest

Let me go through an example because this makes things a lot more clear. For example, on the first statement date, you charge $100 on the first day and you wait 15 days, 

On the sixteenth day, you charge another $100 so your statement balance is actually $200, $100 plus another $100, and you don't do anything for the rest of the same period

For this example let's consider a month where there are only 30 days, in order to calculate the average daily balance, you can actually just go in your credit card and look at what your total balance is for that credit card for that day and you do this for 30 days add it all up and you divide that by 30. That's your average daily balance

We're going to do the simple math instead where we go okay 15 days of it will have $100 in it and the rest of the 15 days of a 30-day month it's going to have $200 in it 

We just do the simple math, 100 x 15 and then another 200 x 15 and then you divided by 30 to get the average daily balance of $150.

  • $100 x 15 + $200 x 15 divided by 30 = $150

Is the first half you owe $100, the second half you owe the average of that would be somewhere in between, in this case, it's exactly $150

When you see an APR on your credit card is actually something like 15 18 22 %, that is an annual percentage rate, it's the effective rate I wish you'll get charge in the whole year, but when you consider it on per month basis, this is not exactly what you're going to get charged

  • 15% APR / 365 = 0.041%

You're not going to get charged 15% in a single month, roughly you can divide this by 12 in order to get it, but we wanted to divide it by 365 days because some days of the month have 28 days 29, 30 or 31, so we divide by 365 we get 0.041%

Now in this current month that we're considering has 30 days so we multiply this by 30 and then we multiply 0.041% by 30 and then we get 1.233%, so if our average daily balance is $100 we can easily do this math in our head the interest that you owe would be $1.23

  • $150 x 1.233% = $1.85 interest

Another example, if your average daily balance is $1,000 it would be $12.33

 You can see it's highly dependent on the average daily balance for your credit card on that month, this means that if you do owe something on your credit card and you're paying interest the earlier you pay your payment the less interest you have to pay

For example, you may want to do two payments a month where the first payment is after your first paycheck and you pay some amount maybe half of it already then you would essentially reduce your average daily balance and in essence reduce the total interest that you pay

If it happens you get paid weekly or daily, you can go in there and keep on just paying a little bit as much as you can every single day if you want and you're going to effectively reduce your average daily balance a little bit more

This really just says every single day that you have a smaller balance on your credit card the less interest you have to pay.

I hope this helps you understand how a credit card calculates the interest it charges you every single month

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