Calculating Interest Costs

Have you ever thought about how interest is calculated on your credit cards? Knowing this could actually help you work out a payment plan in advance of a purchase.  You can also check your card calculations on occasion (although, it’s unlikely it’s being calculated incorrectly).

Figuring out interest charges is a five step process:

  1. Most companies calculate interest using the average daily balance method. To get to this number, you need to add the balances on each day during the billing period. The balance equals payments subtracted from purchases.
  2. Then divide that balance by the number of days in the billing period.  Let’s say the balance comes out to $18,000. You divide that by 30 days in the billing period to give you an average daily balance of $600.
  3. Calculate your monthly interest by dividing the APR by 12 (number of months in the year). So, if your APR is 14.99% divide that by 12 for a monthly interest rate of 1.2491.
  4. Turn that into a percentage of .012491 (1.2491 x 100)
  5. Multiply that percentage by the average daily balance of $600 to get $7.49. That is the monthly interest charge.

Calculation Your Minimum Payment

You may be curious to know how a minimum payment is arrived at. Most credit card companies require that at least a portion of the balance gets reduced each month. Find out what percent the card issuer requires the balance to be reduced by. Usually, it is between 3% and 5% of the balance at the end of the billing period. In the example above, the period ending balance is $600.

  1. The interest payment as calculated above is $7.49 for the end of the period.
  2. Add this to the balance. So, the total balance is $607.49. If the credit card company required 5% of the balance to be reduced, multiply that by $607.49 for a minimum of $30.37.

Note that most credit card companies round this number down. So, the minimum would be $30. Also, most credit cards will not go below $15 per month as a minimum balance.

The above is a good math exercise to calculate monthly credit card interest. There are also other ways you can get at this number. However, if you are not math inclined, you can always go online to one of the several loan calculators there. With just a few entries and mouse clicks, all of the credit card interest charges will be done for you.