Credit card interest, usually expressed as an annual percentage rate (APR), is the rate you’re charged on any unpaid balances each month.
Card issuers may charge interest when you don’t pay your full statement balance by the due date. They may also immediately start charging interest on things like cash advances. Your card may have a different interest rate for different types of credit card debt, such as balance transfers, purchases and cash advances.
Your credit card agreement can help you understand how different interest rates are applied.
Let’s explore some of the ways credit card companies can calculate monthly interest charges, including the daily balance method and the average daily balance method.
Daily balance method for calculating credit card interest
The daily balance method is the most straightforward way to calculate credit card interest. Here, you’d multiply the balance on your credit card each day in the billing cycle by a “daily periodic rate” to calculate the interest. The daily periodic rate is the APR that applies to the balance, divided by 365.
If the credit card issuer compounds interest daily under this method, the interest charged from the prior day will be added to the balance of the current day. That balance will be multiplied by the daily periodic rate to determine the interest charged for the current day.
Your credit card bill includes the interest charges for each day in the billing cycle.
Average daily balance method for calculating credit card interest
The average daily balance method is more complicated than the daily balance method, but you can calculate it in 3 steps:
1. Convert the annual percentage rate to the daily periodic rate
First, calculate the daily periodic rate by dividing your APR by 365, the number of days in a year.
2. Determine your average daily balance
Next, check which days are included in your billing period. Interest charges depend on the balance on each of those days, so you’ll need to record what your daily balance was on each day during the billing period. This may be different from the number of days in that month if, for example, the issuer only closes billing periods on weekdays
Add up all the daily balances and divide them by the number of days in the billing period. This is your average daily balance.
3. Calculate your credit card interest
Finally, multiply the average daily balance by the daily periodic rate and the number of days in the billing period. This is your total interest for that billing period.
Average daily balance with compounding interest
Issuers may also use a variation of the average daily balance method that includes compounded daily interest from the previous day. If the credit card issuer compounds interest daily under this method, the prior day’s interest charge is added to your daily balance.
