Interest on Credit cards Explained

Credit card interest is the cost a client pays to borrow money from a credit card lender. It's typically charged when you carry a balance past the due date of your billing cycle. The interest is calculated as a percentage of the amount owed, and this percentage is referred to as the Annual Percentage Rate (APR). The percentage rate can be fixed (the rate doesn’t change or variable (the rate will fluctuate), depending on the provider.

Most credit cards give you a grace period (usually around 21–25 days) during which the balance can be paid without incurring interest. This is generally the period within which your statement is produced and the payment due date.

However, if you don’t pay the full balance by the due date, the card issuer will charge interest on the unpaid amount.

How is Credit Card Interest Calculated?

The interest is calculated daily or monthly, depending on the terms of your card, using the APR divided into a periodic rate. Here's how it works:

1.      Determine the Daily Periodic Rate (DPR)

The Daily Periodic Rate is the amount added up for each day in the month to create your monthly interest charge. The Daily Periodic Rate is determined by dividing the Annual Percentage Rate by 365 days of the year.

Formula: DPR= APR / 365

For example, if your APR is 18%, the DPR would be:

18/365= 0.0493% (or approximately 0.000493 in decimal form)

2. Calculate the Average Daily Balance (ADB)

The Average Daily Balance is the sum of your balance each day during the billing cycle, divided by the number of days in that cycle.

3. Calculate the Interest

Formula:

Interest = ADB × DPR × Number of Days in Billing Cycle

Tips to Minimize Credit Card Interest

Pay the Full Balance Monthly

Lenders will always advise you to pay your balance in full by the due date to avoid any interest.

It is important to note that a credit card is a lending contract between the lender and the customer. If the customer doesn’t respect his part of the contract, fees also known as interest will be applied. In other words, if a customer pays all their credit card balance a day after their payment due date, he will be liable to pay interest on all the amount used.

Pay More Than the Minimum

In general, paying more than the minimum doesn’t stop the interest but may reduce it as interest is only applied to the amount used on the credit card.

Avoid Cash Advances

Cash advance refers to cash withdrawals from cash machines and other types of transactions. Most credit cards allow you to withdraw cash from a cash machine as you would with a debit card, up to a certain amount. This is known as a cash advance. These transactions always come with fees attached to them. Cash advance is not limited to cash withdrawals, it can also include buying foreign currency, spending money on gambling, including lottery tickets and scratch cards, share dealing, or buying cryptocurrency and more.