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how does credit card interest work
16 Jul 2018

How Does Credit Card Interest Work? A Complete Guide

Getting a credit card can be a huge step in an individual’s life. Trying to generate good credit is essential to getting financing for larger things later in life.

Credit cards do come with a few risks, though.

First, you have to know yourself well enough to trust in the fact that you’ll handle your payments and stay out of excessive debts. The debts accrue due to the fact that cards have a number of charges for late payments on top of the fact that they accumulate interest.

Before getting a credit card, ask yourself “how does credit card interest work?”

If you can’t come up with the answers, we’ve got the basics for you in this guide.

How Does Credit Card Interest Work?

Different credit cards have different interest rates, but there are a few constant rules that you can apply to understand your interest. You’ll want to know exactly what you’re going to be paying and why.

If you understand that, you can have a better idea of how much you need to work to pay your bills, and how long those bills will be hanging around.

It’ll be helpful to quickly cover the idea of interest and how it works. Interest operates by taking a percentage of a total amount and adding that percentage to the amount. For example, if your interest rate was .1 percent and your balance was $10, the interest would be one dollar.

The next day, your total balance would be eleven dollars (the previous ten, on top of the one that was added in interest). The process repeats over and over throughout specific time periods.

For example, if your interest accumulated daily, your eleven dollars would have .1 percent added on to it the next day. That means your balance would bump up to $12.10, get more interest added the next day, and so on.

You can understand why interest is such a powerful thing. It keeps growing if you don’t do anything to lower your balance.

1. Understand Your Card’s Rates

Most credit cards will have an annual percentage rate. It’s tempting to think that this rate will be constant throughout the year, but the rate actually adjusts to your balance day by day.

For this reason, you have to do a little math to figure out where you’re at in the moment. The first thing that you need to do is turn your annual rate into a daily rate.

2. Converting Your Rate

Identify your annual rate and divide it by each day of the year. For simplicity’s sake, imagine that your annual rate is 36.5% (it probably won’t ever be that high, but it makes our math a little easier). If you divide that number by 365, you get .1.

In that case, your daily rate would be 0.1% of whatever balance you have your account. As we’ve discussed, that interest continues to compound and increase every day.

This adjusted percentage is going to be your daily interest rate. Make sure to know that rate because it will be important every time you are trying to calculate how much interest you’ve accrued during the billing period.

3. Figure Out Your Daily Balance

Your billing period will determine which days interest has accrued for that payment. Go through each day and write down each balance, starting with the first day of the period and ending with the last. Once you have all of those numbers down, divide that number by the number of days in the billing period.

The number you get will be your average daily balance for that period. Take your average daily balance and multiply it to your daily interest rate. The product of those two numbers will give you your total interest cost for that billing period.

Ways to Keep Interest Low

There are a few things that you can do to make sure that your interest rate doesn’t go up, as well as a couple of things you can do to keep it low right off the bat.

First and foremost, if you already have good credit, you’re likely to get a better interest rate. Additionally, if your score was bad once but is improving, you may be in a position to ask for a lower rate.

Another thing you need to do is keep up on your payments. That will be a primary factor in determining how much interest you accrue. If you can, try paying your bill in full every month.

If you can’t fully cover your bill each month, try to pay more than the minimum. Finally, you can make multiple payments a month and that will do some damage to your average daily balance.

Be Responsible

Having access to thousands of dollars with the option of paying it back over time is something that a lot of people have a hard time handling. Credit card debt is at an all-time high, and this is because people don’t often consider the consequences of spending unwisely.

Keep in mind that there are a number of additional fees that come along with a card. There is the annual fee, which comes just as a general fee for possessing a card. Then there’s interest, which we have covered.

Additionally, there are foreign transaction fees, late fees, and advance fees. These will all be subject to change, depending on which bank you go through and which card you choose.

If you use your card wisely and pay your balances, you will end up with better credit for it. This will come in handy when you want to settle down and buy a house, car, wedding ring, or any other large financial decision.

Contact a Professional

Are you looking to improve your credit, understand credit cards, or deal with any other financial issue in your life? If you’re struggling to manage your bills while trying to understand your financial situation, there are professionals out there that can help you with personal finance.

Still asking yourself “how does credit card interest work?” If the answer is yes, contact us and we can help.