For all the benefits credit cards can offer, one of the major drawbacks is interest. When you don’t pay your balance in full each month, you get charged interest on that balance.
Have you ever wondered how this interest is calculated and how this information can help you determine the best time to pay off your credit card balance? Understanding how your credit card’s daily balance affects your interest rate can save you money and help you manage your account more effectively.
Credit card interest explained
Credit card interest is the cost of borrowing money from your credit card company. It’s typically expressed as a percentage and added to your outstanding balance each month. The higher your interest rate, the more you’ll pay back in addition to the amount you borrowed.
Interest and APR (annual percentage rate) are often used interchangeably, but they refer to different things. Interest is the amount you pay for borrowing money, while APR includes interest as well as any additional fees or charges associated with the loan or credit card.
For credit cards, the interest and APR is usually the same, but it’s important to consider both when managing your daily balance and overall credit card debt.
How your average daily balance affects your credit card interest rates
So how is credit card interest calculated? Many credit card companies use the average daily balance method to calculate the interest they charge you. This means that your interest is based on the average amount you owe each day during your billing cycle.
This can significantly impact the interest you pay, as your interest rate is calculated daily and applied to the average balance rather than just the balance at the end of each billing cycle.
A high average daily balance can lower your credit score if it results in a high utilization rate (the percentage of available credit being used). This can make it harder for you to qualify for loans or credit cards with lower interest rates in the future.
Also, if you consistently carry a high daily balance or make late payments, your credit card company may apply a penalty APR to your account. This is a higher interest rate that can be around 29.99% and can significantly increase the amount of interest you pay each month. To avoid this, it’s crucial to keep your daily balance low and make on-time payments.
➤ LEARN MORE:What is the average credit card interest rate?
How to calculate credit card interest
To calculate your monthly credit card interest using the average daily balance method, you can use this credit card interest formula:
For example, let’s say you have a credit card with an 18% annual percentage rate (APR) and a $1,000 balance. If your monthly billing cycle is 30 days and your credit card company uses the average daily balance method, your interest for that month would be calculated like this:
- Day 1: ($1,000 x 0.18) / 365 = $0.49
- Day 2: ($1,000 + $0) x 0.18 / 365 = $0.49
- Day 3: ($1,000 + $0 + $0) x 0.18 / 365 = $0.49
- And so on until day 30
After calculating the interest for each day, it would be added together to get your total interest charge for the month.
Here’s how to calculate credit card interest by month assuming your balance doesn’t change:
So for our example above, calculating the monthly interest would look like this:
$1,000 x 0.18 x 30 / 365 = $14.79 in one month
➤ FREE TOOL:Monthly credit card interest calculator
Strategies to manage and lower your daily balance
If your credit card issuer is using your average daily balance to calculate interest, this method can result in a higher payment because even if you pay off your balance in full at the end of the billing cycle, you still accrue interest on the average daily balance throughout the month.
If you’re looking to limit your interest payments as much as possible so you can maximize rewards and other credit card benefits, here are some strategies that can help:
Pay off your balance in full every month
This may seem obvious, but paying off your balance in full means you won’t accrue interest on your balances. Doing this also means you’ll need to manage your spending and be mindful of how much you can realistically afford to pay with your credit card each month.
Make multiple payments throughout the month
If possible, try making multiple payments toward your credit card balance throughout the month. This can lower your average daily balance and ultimately reduce the interest you pay.
Keep track of your spending
Knowing how much you spend on your credit card each month can help you plan your budget and avoid overspending, which can lead to a higher daily balance.
Avoid unnecessary purchases
It’s tempting to use your credit card for every purchase, but try to limit it to essential items only. Or if you’re trying to leverage rewards by earning a welcome bonus for example, plan ahead to see which expenses you can put on the card so you aren’t tempted to make extra unnecessary purchases just to hit that minimum spend amount in time. Doing this will help keep your daily balance from increasing unnecessarily and help prevent it from getting out of control.
Frequently asked questions
Can I reduce my average daily balance easily?
If you feel your credit card balance is too high and it’s resulting in higher interest fees, it’s best to take steps to reduce that balance as soon as you can. Consider pausing the use of your credit card and focus on paying down your existing balance.
Budget to pay more than the minimum payment on your card each month. Keep in mind that reducing your average daily balance may take time and discipline, but it can lead to significant savings on interest charges.
Is it better to pay off my credit card balance in full or make partial payments?
It is always better to pay off your credit card balance in full if you are able. This helps avoid interest charges and can improve your credit score. However, if you cannot pay the full balance, making multiple payments throughout the month can still help reduce your daily balance and ultimately lower your interest charges. It’s important to make at least the minimum payment by the due date to avoid any late fees or negative impacts to your credit score.
How can you find out if your credit card uses the average daily balance method?
You can typically find information about your credit card’s interest calculation method in the terms and conditions or your monthly statement. If you’re unsure, you can contact your credit card issuer directly to ask about how they calculate interest.
➤ LEARN MORE:Does carrying a credit card balance hurt your credit score?
The bottom line
Understanding how your credit card’s average daily balance impacts your interest rate is key for effectively managing your credit card debt and also making better use of your card benefits and rewards. If you are paying an annual fee in exchange for travel benefits or earning cash back or points on purchases, paying high interest fees each month can negate some of the perks of using your card.
It’s easy to determine if your card issuer is using the average daily balance method to calculate interest by checking your statement or asking directly. Regularly monitoring your credit card activity and staying within a budget for credit card expenses can also help in successfully managing and lowering your daily balance.
