How are Credit Card Interest Rates Calculated?

When you get a credit card, it requires you to pay the minimum balance to avoid falling into debt. The downside of carrying a balance is that you will have to incur credit card interest rates. Interest rates can put a significant financial burden on your shoulders. It is referred to as Annual Percentage Rate or APR. However, in most cases, your credit card interest compounds daily.

Sometimes, you will have to bear no interest charges on your credit balance. It happens when you have been offered a grace period or if your credit card has a 0% APR period. The other situation that would result in no interest charges on a balance is when your credit card issuer decides to waive interest due to the COVID-19 pandemic.

Let us take a moment to understand what this interest is and how to calculate credit card interest rates.

What are credit card interest rates?

It is a percentage of the balance amount charged by the issuing bank or financial institution. The interest applies when you choose to pay the minimum balance or miss your monthly payment amount in full. If you pay your credit card’s outstanding balance amount before the due date, there is no interest charged by the issuing bank. It is imperative to know the interest rate on your credit card before applying for one. It is worth noting that the rate of interest depends on your credit score. A higher credit score can get you a lower interest rate.

How are credit card interest rates calculated?

You can calculate your credit card interest rate based on the following three steps:

• Convert Annual Percentage Rate (APR) to daily rate
  Most credit card issuers compound interest daily, which means that your interest amount is added to your principal balance at the end of each day. So, you will need to convert your APR to a daily rate. You can do that by dividing your APR by 365 days.
  Some credit card issues divide the APR by 360 days. However, it does not make much of a difference. The outcome will remain almost the same. The result that you get after diving your APR by 365 days is known as periodic interest rate or daily periodic rate.


• Find out your average daily balance
  This step is quite tedious as you will have to know every day’s balance throughout the entire billing cycle. Your credit card interest rates depend on the balance of each day. For instance, if your billing cycle is 20 days, you will need to know the exact balance for all 20 days.
  Start with the unpaid balance on your credit card statement. It is the amount carried over the previous month. Making purchase transactions increases the balance amount, and when you pay off your debt, it goes down. You can use your transaction information on your credit card statement to go through the billing period and jolt down each day’s balance amount.
  After writing down all the balances, add all your balances and divide by the number of days of your billing cycle. The produced result is called the average daily balance. Keep in mind that you will need to include balances from previous months. Also, make sure to exclude any payments made during your current billing cycle when you add current balances.


• Calculate interest charges
  After finding the average daily balance and daily rate, you will need to calculate your interest charges. You will need to multiply your average daily balance by the daily rate. After that, multiply the amount you receive by the number of days in your credit card billing cycle.
  Your actual interest charge depends on whether your credit card issuer compounds interest daily or monthly. It means that your interest charge may be different than this amount. It is worth noting that compounding is a way of adding the accrued interest into the unpaid balance. Due to compounding, you end up paying more than your APR in interest.

What are the factors determining your credit card interest rates?
Several factors go into influencing credit card interest rates, such as:

• Prime rates
  The credit card interest rates are determined based on the prevailing interest rate or prime rate. It acts as a starting point for interest rates to be set on credit cards. It has a big impact on credit cards with variable APR, as it is subject to changes due to market conditions.


• Credit history
  Before assigning an interest on your credit card, your issuing bank will consider your credit report and credit score. Your credit score indicates whether or not you are a creditworthy person. Having a higher credit score ensures a lower interest and vice-versa.


• Different APRs
  The credit card interest rates calculation is referred to as APR - Annual Percentage Rate. A single credit card can have multiple APRs. For instance, there are different APRs applied on cash advances, purchases, balance transfers, and promotion rates. Some credit cards’ APRs change periodically, while others are fixed.


• Promotional offers
  You may have observed that some banks offer 0% interest for a specific after purchasing a credit card. The interest-free period can range between 6 months to 12 months. But, as and when the promotional period ends, the interest rates increase substantially.


• Payment history
  Another factor that influences your credit card EMI interest rate is the payment history. For instance, if you miss repayments, you will have to incur higher interest rates. It is as simple as that.

How to lower my credit card interest rate?

The best part about a credit card is that you have control over some of the factors that determine its interest rate. For instance, your credit score depends on how you manage your credits. Having a higher credit score can get you a lower interest rate. Similarly, a lower credit score leads to a higher credit card EMI interest rate.

Regardless of the credit cards’ APR, you can reduce your interest rate in the following ways:

• Pay your credit card bill in full and on time to avoid interest charges.
• Make sure to pay more than the required minimum payment if you are unable to make full payment.
• To decrease your daily balance, try to make payments more than once a month.

So, now that you know what is a credit card interest, how to calculate it, and the factors influencing it, you can take measures to avail of a lower interest rate and enjoy credit card benefits freely.