How Does Credit Card Company Calculate Interest
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Reviewed by Calculator Editorial Team
Credit card companies calculate interest based on your spending, outstanding balance, and the card's annual percentage rate (APR). The calculation method varies by card issuer, but most use either the daily balance method or the average daily balance method.
How Credit Card Interest is Calculated
Credit card interest is calculated based on your spending, outstanding balance, and the card's annual percentage rate (APR). The calculation method varies by card issuer, but most use either the daily balance method or the average daily balance method.
Key Formula
Interest = (Daily Balance × Daily Interest Rate) + (Previous Interest)
Where Daily Interest Rate = APR ÷ 365
The calculation process typically follows these steps:
- Determine the daily balance or average daily balance for each billing cycle
- Calculate the daily interest rate by dividing the APR by 365
- Multiply the daily balance by the daily interest rate to get the daily interest
- Add the daily interest to any previous unpaid interest
- Repeat for each day of the billing cycle
- Sum the daily interest amounts to get the total interest for the billing cycle
Credit card companies calculate interest on purchases and balances separately, with different rules applying to each.
Interest Calculation Methods
Credit card companies use different methods to calculate interest, with the most common being the daily balance method and the average daily balance method.
Daily Balance Method
With the daily balance method, interest is calculated on the outstanding balance each day. The formula is:
Interest = (Daily Balance × Daily Interest Rate) + (Previous Interest)
This method can result in higher interest charges if you carry a balance, as interest is calculated on the full balance each day.
Average Daily Balance Method
The average daily balance method calculates interest based on the average of your daily balances over the billing cycle. The formula is:
Interest = (Average Daily Balance × Daily Interest Rate × Number of Days in Billing Cycle)
This method typically results in lower interest charges than the daily balance method, as it doesn't penalize you for carrying a balance.
Note: The calculation method can vary by card issuer, so it's important to check your card's terms and conditions.
Interest on Purchases
Credit card companies calculate interest on purchases separately from interest on balances. The interest rate on purchases is typically higher than the interest rate on balances.
The calculation process for interest on purchases typically follows these steps:
- Determine the purchase amount and the purchase APR
- Calculate the daily interest rate by dividing the purchase APR by 365
- Multiply the purchase amount by the daily interest rate to get the daily interest
- Add the daily interest to any previous unpaid interest
- Repeat for each day of the billing cycle
- Sum the daily interest amounts to get the total interest on purchases for the billing cycle
Interest on purchases is typically calculated using the daily balance method, meaning interest is calculated on the full purchase amount each day.
Note: The grace period applies to interest on purchases, meaning no interest is charged for the first 21-25 days of the billing cycle.
Interest on Balances
Credit card companies calculate interest on balances separately from interest on purchases. The interest rate on balances is typically lower than the interest rate on purchases.
The calculation process for interest on balances typically follows these steps:
- Determine the outstanding balance and the balance APR
- Calculate the daily interest rate by dividing the balance APR by 365
- Multiply the outstanding balance by the daily interest rate to get the daily interest
- Add the daily interest to any previous unpaid interest
- Repeat for each day of the billing cycle
- Sum the daily interest amounts to get the total interest on balances for the billing cycle
Interest on balances is typically calculated using the average daily balance method, meaning interest is calculated based on the average of your daily balances over the billing cycle.
Note: The grace period applies to interest on balances, meaning no interest is charged for the first 21-25 days of the billing cycle.
Interest Charges
Credit card companies charge interest on purchases and balances separately, with different rules applying to each. The interest charges are typically added to your statement balance and are due in full with your minimum payment.
The interest charges are calculated based on the interest rates and calculation methods specified in your card's terms and conditions. The interest rates can vary based on your creditworthiness, spending habits, and other factors.
It's important to pay your credit card balance in full each month to avoid interest charges. If you carry a balance, you can reduce your interest charges by making payments throughout the billing cycle.
Interest Cap
Some credit card companies impose an interest cap, which limits the amount of interest you can be charged on your balance. The interest cap is typically a percentage of your credit limit or a fixed amount.
The interest cap is designed to protect you from excessive interest charges if you carry a balance for an extended period. The cap is usually applied to the interest on balances, not the interest on purchases.
It's important to check your card's terms and conditions to see if an interest cap applies and what the cap amount is. If you're carrying a balance, you may be able to reduce your interest charges by making payments throughout the billing cycle.