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Most of us understand that “interest” is the money we pay back when we borrow money from credit card companies by using a credit card. A credit card is considering “revolving debt.” This means payments aren’t fixed to a specific amount each month (like a car loan or mortgage) but depend on how much we have borrowed at any given time. The interest we pay will vary depending on how much we have borrowed.
Most of us are also familiar with credit card interest rates — usually a number between 0 % and 22.99 %, with default rates going as high as 29.99% in some cases. We may have also heard the terms “prime rate” and “over prime,” which means the percentage rate over the prime rate. Most credit card interest rates are calculated as “Prime + X,” where X is amount of interest “over prime.” You can learn more about how the prime rate is calculated in this article, Credit Card Prime Rates Explained.
Variable Interest Rates
Most credit cards today have variable interest rates, which means they change as the prime rate changes. When the prime rate goes up, your interest rate goes up. If the prime rate goes down, your credit card interest rate will drop, too.
On the other hand, most mortgages, bank loans and car loans are “fixed,” meaning whatever the prime rate does, your interest rate stays the same.
Knowing all this, the question remains: How much interest are you really paying on your credit card?
Calculating Interest Charges
Since credit card balances vary, most credit card companies calculate the interest you’ll pay based on your average daily balance for a given statement period. You can calculate your average daily balance by adding up the balances on each day, then dividing it by the number of days in that billing cycle.
Here is an example:
Your Balance for Days 1 – 15 of a Billing Cycle = $100
15 X 100 = $1500
Your Balance for Days 16 – 30 = $50
15 X 50 = 750
$750 + $1500 = $2250 / 30 = $75
$75 is your average daily balance, or the amount of money you would pay interest on during that billing cycle.
Next, you’ll need to look up your APR (Annual Percentage Rate). Now, divide your APR by 12 to get the monthly rate. If you have an APR of 13.99, your monthly rate would be .011658. Multiply that number with your average daily balance, and that’s your interest charge for the month, in this case, it would be 87 cents. (Not bad, but $75 is not a very high balance, either!)
Add a few zeros to your average daily balance ($7500) and you’ll find yourself paying $87 per month to borrow that money — and you’ll pay that every month you carry that balance.
Interest Rate Calculators
Concerned with how much interest you’re paying on your credit cards? Several online credit card interest calculators can show you how much money you’ll save in interest — and how quickly you’ll pay off your debt — by making fixed payments over the minimum payment due each month.
Using these calculators is great incentive to pay off your debt, as you see exactly how much you’re paying in finance charges (interest) each month.
Don’t forget, once you get finance charges on your credit card, these become part of your average daily balance… You pay interest on your interest charges, too.
Here are a few of my favorite interest rate calculators:
BankRate.com’s Minimum Payment Calculator – – Enter your credit card balance, interest rate, and how your minimum payment is calculated, and this calculator tells you your current minimum payment and how long it will take to pay off your credit card (if you only make payments and don’t add to the balance on the card), making the minimum payments. It also calculates how much interest you’ll pay each month. You can also enter a fixed payment amount you are willing to make each month, and see how much you will save by making more than the minimum.
ConsumerCredit.com — This website also offers an easy-to-use credit card interest rate calculator. Enter the amount you owe, your APR, the percent of your balance that makes up your minimum payment, and your current minimum payment to find out your interest charges for as long as you carry a balance, how many billing periods it will take to pay off the card, and how many years that will be. It was sobering to see that, on a credit card with an APR of 9.99% and a balance of $1000, making only a minimum payment of $40 per month, it would take 2.4 years to pay off the card and it would cost more than $125 in interest.