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How do you calculate your credit card interest?

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The interest charged on credit cards differs from one financial institution to the next. However, did you know that you can have a credit card and not get charged any interest? This is possible because the interest charged on credit cards is due to the debt accrued from one month. This article takes a deep dive into how credit card interests are calculated.

credit card interest

1. The Balance Based System

The interest charged on a credit card is calculated based on the balance of your account at the beginning of the month. This is what is known as a “balance-based” interest system. Most financial institutions will charge you interest on your outstanding debt in arrears. If you have a balance of $1,000 at the beginning of the month and make purchases worth $500, for instance, you will be charged interest on $1,500 (the difference between your starting balance and your current balance) for that month.

The rate charged by financial institutions also varies from one to another. The type of credit card you have also determines how much you are charged in interest. For instance, rewards cards often come with higher rates than standard cards. Similarly, business cards are usually more expensive than personal cards. The best way to avoid paying too much interest is to pay off your credit card bills before they become due and start using your card only when you need it.

2. The Average Rate System

Most financial institutions use this kind of interest system. It works by averaging out the daily balance of your account over a month and charging you interest on that average. You will pay less interest than the balance-based system because your credit is averaged out over a month. You may be charged interest on a smaller amount than the actual outstanding debt in your account at the beginning of the month.

3. The Annual Percentage Rate

The credit card interest calculator utilizes the annual percentage rate system. This system considers :

  • The billing cycle period
  • The average balance daily
  • The Annual Percentage Rate (APR)

For instance, when the billing cycle period is monthly, it will consider the average balance over a year. The APR calculation is based on these three factors. The interest rate is determined by dividing the amount of interest by the outstanding debt in your account at any given time.

An Example of the APR Calculation

You have a credit card with an outstanding debt of $1,000. The billing cycle period is 31 days. The average balance is calculated daily. The interest rate is determined by dividing the amount of interest by the outstanding debt in your account at any given time.

The APR = r = 15% per annum.

Thus, you will pay $15 in interest for every $100 you owe on your credit card account every year (i.e., 15% per year).

Conclusively, the interest charged on credit cards is one of the highest in the world. The interest rate is not regulated and is determined by banks, not the government. Therefore, limiting the debt accrued on your credit cards would be best. According to SoFi Invest, “If you‘re paying more than 16% interest on your credit card, a personal loan from SoFi could help you save thousands.”

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