Calculating credit card interest made simple

At TPG, we always advise clearing your credit card balances completely each month. Even the top rewards credit cards don't offer enough rewards to outweigh the interest you incur by carrying a balance.

If you're carrying a balance, understanding how your interest is computed can help you anticipate your monthly payments. The figures on your statement can be perplexing, leading you to ask, "How is the interest on credit cards determined?"

If that sounds familiar, we have the answers you need. Here’s everything you should know to determine how much interest you will incur on a credit card.

What is the method for calculating credit card interest?

Credit card interest refers to the fees charged by the credit card issuer for borrowing money, which occurs when you carry a balance. This interest is commonly known as APR, or "annual percentage rate." Essentially, the APR indicates the yearly interest you'll accumulate on your balance, in addition to any extra fees.

For instance, if your credit card balance is $1,000 and your APR stands at 21%, you'll accumulate $210 in interest over the course of a year.

Calculating credit card interest

Credit card interest generally accumulates on a daily basis, so it's beneficial to understand how to compute it based on whether your charges are daily or monthly; you won’t simply face a single interest charge at the end of the year.

To convert your APR into a monthly interest rate, simply divide the 21% APR by 12. For a balance of $1,000, this results in a monthly interest rate of 1.75%, equating to a monthly cost of $17.50.

To calculate the daily interest, divide the APR by 365, yielding an approximate daily interest rate of 0.06%, which translates to around 58 cents per day.

These calculations assume a constant balance of $1,000. If you reduce your balance monthly, your interest charges will be lower. Conversely, if you increase your balance by making additional purchases or not paying off accrued interest, your total interest charges will rise accordingly.

Different types of credit card interest

To add to the complexity, credit card issuers may apply various types of interest rates.

In the previous example of calculating credit card interest, we used a "fixed rate" APR, which, as the name suggests, is an interest rate that remains constant.

On the other hand, many credit cards feature a "variable rate" APR, meaning your interest rate can fluctuate monthly based on federal rates. If you have a variable rate APR, be sure to check your APR on your statement each month and adjust your monthly interest calculations accordingly.

Some cards offer a lower "promotional APR" for a limited time. If you're utilizing one of these, keep a close eye on the promotional period's end date and recalculate your monthly interest based on the new APR once it concludes. Ideally, aim to pay off your entire balance during the promotional period to avoid accruing any interest afterward.

Key takeaways

If you don't examine your credit card statement closely, it’s easy to think that credit card interest is too complicated to grasp. However, with an understanding of how credit card interest is calculated, you can clearly see how your annual, monthly, and daily interest amounts are determined.