How to Calculate Credit Card Interest

Credit cards can make shopping easier in some ways, but they can also make it much more expensive. If you don’t pay off your balance every month – or fail to pay the bill at all – the interest charges quickly add up. If you’ll be making a major purchase that you won’t be able to pay off right away, then take a moment to calculate the potential interest that will come with it, to decide whether you can truly afford the purchase in the long run.

Here is a breakdown of how you can calculate your estimated credit card interest:

• Know the rate

  Credit card issuers are now required to publish your credit card rates on your periodic statements, making this step easy. Simply pull out your most recent statement and locate the rate.

  The different rates associated with your card will be grouped together and will show the balance that is subject to each interest rate. This is especially useful if you have conducted a balance transfer or cash advance with your credit card, as those types of transactions typically are subject to a different rate and possibly a different calculation method.

• Know the average daily balance

  Look for the “balance subject to finance charge” on your statement.

  If you are trying to determine interest charges for a planned purchase, you will need to know what calculation method your credit card issuer uses. Credit card companies commonly use an average daily balance method, meaning interest on outstanding balances accrues every day.

  To determine the average daily balance, add up the balance for each day noted in your statement and divide by the number of days stated on the statement. So, if there are 30 days on your statement and for the first 15 days, the balance was $500 but the last 15 days the balance was $1,000, your average daily balance would be $750.

• Know the number of days in the billing cycle

  This is another piece of information that is readily available on your statement. It will help you know how many days the interest will accumulate.

• Find an online calculator

  If the thought of math makes you sweat, you’re in luck. There are many online calculators to help you calculate credit card interest.

If you prefer to do the calculations by hand…

For the old-fashioned way, follow this method:

1. Divide the interest rate, which is displayed as an Annual Periodic Rate (APR), by 365 to find the daily periodic rate.
   
2. Multiply the daily periodic rate by the “balance subject to finance charge.”
   
3. Multiply the result of #2 by the number of days in the billing cycle.
   
4. The result is the interest that will accrue during one billing cycle
   
5. If you anticipate that you will not pay off the balance in full after one billing cycle, subtract from the “balance subject to finance charge” the amount you expect to pay and calculate the interest again for a second billing cycle. Repeat this step until you get to zero balance and then add together the interest accrued for each cycle.

Here is an example of the calculations for a credit card with a 17.99% APR with an average daily balance of $2,500 and a 30 day billing cycle:

• .1799/365 = 0.0004928 (daily periodic rate)
  
• 0.0004928 * 2,500 = 1.232 (balance)
  
• 1.232 * 30 = $36.96 (total credit interest)

Avoid the Interest Charge

If the results of your calculations give you a mild heart attack, don’t fret. You can usually avoid credit card interest charges altogether by paying your balance in full during the billing grace period. Most major credit cards offer cardholders at least a 21 day-day period to pay their balance in full to avoid the charges.

Another good tip: If you want to make a large purchase that you won’t be able to pay off in one month, you may also want to consider opening a new credit card. Many credit cards feature a special rate for the first several months. Sometimes these rates are as low as 0%, providing you several months to pay off the balance before any interest charges occur, as long as you pay the minimum due each month.

Editor's Note: Calculations are an estimate based on assumptions. The actual time and cost to pay off your balance depends on the terms of your account and account activity. Your credit card issuer may calculate differently.

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Follow @CreditDonkey or write to Meghan Clark at meghan@creditdonkey.com