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Credit cards are a great tool to help you manage your cash flow, especially if you pay them off entirely every month. If you carry a balance, it’s a good idea to understand how much that delay will cost you. Credit card interest varies significantly not just in the rate, but how it’s calculated.
You might be surprised to know that your card can have several different interest rates. You might have a purchase rate of 10 percent but a cash advance rate of 19.99 percent. This should be clearly stated on your bill.
Your interest rate is typically APR (annual percentage rate). Most cards charge you interest monthly, based on your average daily balance. Here’s how that works. Say your annual rate is 20 percent. The company will divide that by 365 (or 360). If it’s divided by 365, the annual daily interest rate is 0.05479.
The company will then figure out your average daily credit card balance for a billing period. Say you had a balance of $100 one day, but paid $25 the next. Your balance is now $75. Your average daily balance between these two days is $100 + $75 = $175/2 = $87.50.
To get to the interest rate on your bill, the company will multiple the average daily balance by the average daily interest rate by the number of days in the billing period.
For most purchases, there’s a grace period where no interest is charged. That’s how you can have a credit card and never pay interest — you pay it in full before the grace period is up. But for some charges, like cash advances, some companies won’t have a grace period, and interest begins to accumulate right away.
Most cards, either on a monthly or daily basis, charge interest on the entire outstanding amount. If that outstanding amount includes interest charges from last month, you are paying interest on interest.
So, how do you avoid handing so much cash over to the credit card company? Start by paying more than the minimum. Whatever extra you can apply to the card is less that will be subject to interest next month.
In order to get out of credit card debt, stop using the card. Consider switching to a lower interest rate card. You’ll have the opportunity to pay more against the balance and get out of debt more quickly.
Credit card bills may seem overwhelming, but you can take concrete steps to ensure your outstanding balances stay low. Knowledge is key, as is making determined choices of when and how to use your card.