Know How Credit Card Interest is Calculated before you Fall into a Debt
Know How Credit Card Interest is Calculated before you Fall into a Debt: America is a rich country with more than half of the population having credit cards. A survey done by Gallup in 2014 revealed the percentage of Americans using credit cards with most of them carrying a balance on their cards that are further charged as interest rate in the statement. Gallup is an organization that takes significant surveys across the globe to study and analyzes the attitude and behavior of employees and customers of a company.
Now, the question arises as to what is a balance, what is the interest rate, and how credit card companies calculate interest when it comes to carrying a specified amount of unpaid balance from a defined card billing cycle. As a general prediction, it would not be wrong to say that more than half of the credit card holders keep on paying the amount as reflected in the statement without actually understating the concept. This lack of knowledge and understanding might take your financial savings on a toll at a later stage and so might fall into significant debt.
Understanding the Concept of Interest Rate
The interest rate is a standard rate or a percentage of the credit amount known as Annual Percentage Rate (APR). Respective credit companies finalize the percentage or APR based on the following variations:
- From card to card depending on the benefits provided by the card and the thought process of the credit card issuer.
- From person to person depending on the credit score of the prospective card buyer.
The defined annual percentage rate is expressed on a yearly basis, but card companies use the same to levy charges over the monthly billing period. However, there are different types of interest rates, and each type has its unique feature regarding how it’s applied and how it’s used as interest.
Purchase Rates: This is the charge levied on the standard purchasing price structure that includes your daily routine shopping at the grocery, local shop, fruit market, or internet market.
Cash Advance Rates: This is the charge imposed in case of cash transactions using your credit card. In such a case, an extra percentage of an advance fee is also eligible depending on the amount of cash withdrawn.
Promotional or Introductory Interest Rates: This is one of the lowest interest rate charged on a credit card for only a limited period as an introductory offer or promotional agenda.
Balance Transfer Rates: This is the charge imposed when you transfer the balance amount from one credit card to another card.
Calculation of Interest Rate
Now, to learn how the interest on your credit card purchase is calculated you need to go through a three-stage process:
Stage 1: Conversion of Annual Rate of Interest to Daily Rate of Interest
All you need to do in the first stage is to convert your APR into a daily rate by dividing it by 365. This calculated rate of the interest gives you the daily periodic rate of interest.
Stage 2: Determination of Your Average Daily Balance
Then the second stage you need to determine your average daily balance. Check out the days mentioned in your billing period because the interest charges depend on the balance on each of those days. When you carry forward a balance or an unpaid amount, then the interest on that specified purchase carries with interest for all the pending days of the billing period. Hence, first make a note of all the balances of each day and then divide it by the number of days mentioned in the billing period. This calculated amount gives you your average daily balance.
Stage 3: Putting All the Balances and Interests Together
The final step calls for the actual calculation of how interest works. To go ahead with the calculation, multiply your average daily balance, the daily periodic rate of interest, and the number of days in the card billing cycle. This calculated amount gives you the compound interest or the actual rate of interest that you tend to pay at the end of each billing cycle. However, there is slight variation in the total due balance because it varies from company to company whether the compound interest is calculated on a monthly or daily basis.
Having a credit card is indeed a blessing, but if not paid on time, it can prove to be a curse. Every credit card company offers you a certain period of grace period or a predefined number of days to pay for the purchases you made using the credit card. If you make the payment on time, then there is no interest on the purchases, but if in case the balance is carried forward to another billing cycle and then to another, then you are required to pay a hefty rate of interest. Some card issuers even charge an additional penalty interest rate for late payments or no payments. Hence, it is essential to use it wisely and stay comfortable with your credit card without any worries.