How Is My Credit Card Interest Figured?
Signing up for a credit card means you should read the small print so you have a general idea of what fees, charges, and interest you are going to get. Most people know that a lower APR (annual percentage rate) is better because overall it means you pay less interest. But what exactly does it mean to have a 12% APR? Even though people understand lower is better, not many understand how credit card interest is actually calculated.
Each credit card company might use a different method of interest calculation. There are four different ways to calculate interest, and some may be more advantageous to you than others, so you can always double check with your credit card company in order to find out. Doing so can be a good move before getting a new card.
Average Daily Balance. The most common way of calculating interest. Each day, your balance is worked with, purchases added or credits refunded, and so forth. When it is time for you to pay your bill, all the past daily balances are averaged out. For example, the billing period was 30 days and your daily balanced added up to $1,000. Your average daily balance would be around $33. The interest is figured from that particular balance, which is actually a fraction of the announced APR. This method is the closest way of actually achieving the total APR percentage as is listed on your credit card terms.
Adjusted Balance. This method is one of the better ways for your interest to be calculated because it means you often pay less. Your balance at the end of the billing period is multiplied by another factor related to your APR. However, because this method only takes in payments or credits and no any purchases, the resulting interest charge can be smaller than if purchases had been included in that particular cycle.
Two-Cycle Balance. Sometimes this can come out even and sometimes the interest can be more. The method utilizes balances from two billing cycles, whereas the previous methods only used one. This method tends to be the most confusing to everyone except those doing the calculating at the credit card company; however that doesn’t mean you are getting charged some exorbitant amount of interest. A lot of times this method is used for businesses and accounts with very large limits.
Previous Balance. This is the opposite of the adjusted balance method. Instead of using the balance at the end of the billing cycle, it takes the balance from the beginning of the previous cycle. That balance is the number multiplied by the specific interest factor your card will have depending upon the APR.
You never know what the full amount of interest you will pay is because your spending will vary. Some people may only spend at much as $20 each month on their card, whereas someone else may spend over $500. Paying off your balance in full each month will wipe out any interest at all as there is no money for it to compound on. Overall, the final amount of interest you pay should somewhat reflect the APR percentage in terms of your total carried balances. Even if you still do not fully understand how your credit card interest is calculated, you can always try asking your credit card company or seeking more information yourself.