How the Interest on Your Credit Card is Calculated

You certainly know how to use your credit card, but it's also important that you understand how the interest is calculated on the credit card balance you keep on your card. The calculation your credit card issuer uses to calculate the interest on your credit card can vary, but the most popular calculation is compounded interest based on a daily rate.

What in the world does this mean and how does this work?

Let's take a look.


How to calculate compound interest

A typical credit card statement covers a 30 day period (give or take a day or so). If you carry a balance over from the previous month to the new month, then the interest typically starts to accrue on the first day of your new statement period. So if your new statement starts over again today, June 23 and covers purchases made from today through July 22, then the $100 balance you carried over from last month starts to accrue interest from the date of purchase until you pay it off.

Using a compound interest calculation, your card issuer uses a daily rate to figure out how much interest to charge you, which is determined by dividing the annual rate by the 365 days in the year. You accrue interest on the daily average outstanding balance you've have outstanding throughout the month. So as you make charges during the new monthly period, you begin to accrue interest on the average daily balance you have on your account--if you don't pay the balance off by the due date.

Accrued interest may be nominal when your balances are small but as your balances grow, so does the amount of accrued interest. This is when it seems to spiral out of control, causing many consumers to start drowning in a sea of debt. Credit cards may be a big part of your life, but it's important to understand how your credit card issuer is charging you to use the card they've issued to you. It's the only to determine how much that purchase is really costing you.