Credit Card Interest Rates: Understanding How Interest is Calculated on Credit Cards

Whether you’re comparing credit card interest rates or just want to figure out how much your credit card debt is costing you, it’s important to understand how the interest you are being charged is calculated.

Credit card interest rates (the rates that you are charged) are usually expressed in terms of APR (annual percentage rate). APR is calculated by taking the periodic rate and multiplying it by the number of periods in a year. For example, if you are charged 1% interest per month and are billed monthly, the APR would be 12%. (.01 x 12 = .12).

You have to look at the individual credit card terms to figure out how many periods there are per year and how the creditor determines what balance to charge the interest on. Many credit cards break the APR down into a daily periodic rate, which is figured by taking the APR and dividing it by 365, and then charge you based on the average daily balance. The fine print will tell you what they do.

For example, one of my credit card statements says:

We calculate the period rate or “interest” portion of the FINANCE CHARGE by multiplying the applicable daily period rate by the Average Daily Balance (including new transactions) of the Purchase, Advance and Balance Transfer categories (“Amounts Subject to Interest”), and then multiplying that result by the number of days in the billing cycle.

Maybe your eyes glazed over reading that, but you should be able to find all of the terms they refer to on your statement. In my case, the Average Daily Balance is $0.00, the daily periodic rate is 0.041068%, and the APR is 14.99%.

How the credit card determines what balance to charge the interest on is important, as each method results in a different amount of interest being charged if you carry a balance. The most common method is the average daily balance mentioned previously, but there are also methods like two cycle billing, adjusted balance, and previous balance.

Obviously a lower APR is better if you carry a balance, but you also have to be sure you understand which rates are applied to which types of transactions. Credit cards often charge a different interest rate for things like introductory offers, cash advances or balance transfers, and those rates are often calculated in a different way than the rates charged for purchases.

In short, read the find print and really be sure you understand what you’ll be charged under what circumstances. If you can’t find this information easily on your statement or credit card terms of service, call up the company and ask them where to find it.