You probably know that a credit card accrues interest over time if you don’t pay your full balance each month. Let’s break down how interest works with credit cards.
When you have a credit card, you only have to pay interest if you don’t pay your full statement balance for each billing cycle. That means you can have a credit card without paying any interest as long as you always pay your bill in full! There may be an introductory grace period with a new card, but after that, if you go at least one billing cycle without paying the full balance, you’ll begin to be charged interest immediately. Even when you’re always paying your full amount, you might still be charged fees – so check your credit agreement.
Once you’re in a position where you’re not paying in full and you’re carrying a balance from month to month, you’ll be charged interest. Most credit cards calculate your monthly finance charges based on a method known as Average Daily Balance (ADB). To calculate your ADB, add up your balance at the end of each day of your billing cycle and divide that sum by the number of days in your billing cycle. Then, use your APR (written as a decimal) to determine what your finance charges will be, using this equation:
ADB x APR x Number of days in billing cycle / 365 = Your monthly finance charge¹
This calculation means that if you’re looking to reduce the amount of interest assessed for a pay period, you’ll want to pay down your balance as soon as possible. If you have a check for $1,000 that you want to use to pay off credit card debt, you should send it in immediately rather than wait until you receive your next billing statement. Otherwise, your average daily balance for that period could be higher than if you had made a payment earlier – resulting in more finance charges for you.
Find out what 0% APR really means for credit cards here.
¹ The calculation is based on the Average Daily Balance method used for most credit cards. If you are unsure if your products use an Average Daily Balance calculation or unsure as to the accuracy of your calculation, review your contract and consult a professional to calculate and determine your finance charges.