Credit Card Debt: Understanding APR

Credit cards are crucial financial instruments that help you establish credit and receive rewards while facilitating transactions. Another significant perk of using credit cards is that you will not have to pay additional interest fees if you settle your credit card balance after your payment cycle ends.

However, you should still be aware of the APR on your credit card and how interest accrues. After all, you can encounter a situation where you utilize credit to pay off unforeseen bills over time. In other cases, you may be unable to make your full payment and forced to carry a debt for some time.

So how does interest on credit cards work? Continue reading to understand how credit card companies calculate APR and tips to take advantage of credit without paying astronomical interest rates.

How Credit Card Interest (APR) Works

Simply put, credit card interest is the cost of borrowing money. However, most credit card companies provide you an interest-free grace period between the time they create your monthly statement and the due date for payments. But, if you do not pay off your complete debt by the end of your card’s payment cycle, you will be charged interest on your balance until you fully reimburse the card issuer. Annual percentage rates, or APRs, are frequently used to represent interest rates. Despite this label, interest rates are calculated daily and are charged to you each month.

Steps To Calculate the Interest On A Credit Card

Here are three steps to figure out credit card interest using the example of a credit card with a variable APR of 18%, a 30-day billing cycle, and a daily balance of $1,000. It might help you figure out how much interest you will pay if you do not pay your credit card bill in full by the due date.

I. Convert Your APR To A Daily Interest Rate

Since interest on a credit card is computed daily, you must convert your annual percentage rate (APR) to a daily percentage rate (DPR). Find out if your bank bases its APR calculation on a 365-day or 360-day basis to obtain your DPR. You may often see such information in the small print on your monthly credit card statement.

For example: Divide 18% by 365 to get a daily APR of 0.00049.

You would then multiply your $1,000 credit card amount by 0.00049 to arrive at a daily periodic rate of $0.49.

For each day of your billing cycle, you would accrue forty-nine cents in interest. If daily compounding and no other activity were to occur, your daily balance would increase every day by the interest accrued the day before.

II. Calculate Your Median Daily Balance

You should also figure out your average daily balance, which you may occasionally find on your credit card account. If your credit card statement itemizes daily balances rather than displaying the average daily amount, then begin with the accumulated balance from the previous month, which is your unpaid balance. It increases when you buy something and decreases when you make a payment. Write down each day’s outstanding balance as you proceed through the billing month, using the transaction details from your statement.

Once you have completed that, add up each day’s balance amount and divide the total by the number of days in the billing cycle. Your average daily balance is the outcome.

For instance, your average daily amount will be $1,000 if you have a $1,000 balance every day of a 30-day billing cycle.

III. Calculate Your Monthly Interest Rate

In the final step, multiply your average daily balance, DPR, and the number of days in your billing cycle.

For example, the interest owed for the billing period will be $1,000 x 0.049% DPR x 30 days = $14.79.

If you do not pay the balance before the due date, you will pay more than that over a year because interest increases on outstanding credit card debt.

Methods to Reduce Your Credit Card Interest Rates

If you cannot avoid borrowing money over the long term using a credit card, here are a few steps to take to reduce your interest rates.

These actions can make paying off your credit card debt easier to manage and even help you save money in the process:

i. Negotiate A Lower Annual Interest Rate (APR)

As a cardholder, you should contact your issuer and request them to reduce the interest rate. Seventy percent of consumer requests for reduced credit card APRs are finally granted by card issuers, according to a LendingTree report from April 2022. It works well if you’ve had a single credit card for a while and have always made your payments on time.

ii. Transfer Your High-Interest Balances To A Card with A 0% Balance Intro Annual Interest Rate (APR)

Similar to refinancing for a lower rate, certain credit cards offer introductory balance transfer offers with no interest for a set period (up to 21 months). The additional time you have to pay off your debt might result in hundreds of dollars in interest savings.

However, think about the balance transfer costs (often 3 to 5 percent) and if you can pay it off before the introductory period ends.

iii. Opt For A Balance Transfer To Consolidate Your Debt.

Consider a balance transfer to consolidate your debt if you already have a high-interest credit card bill. Although there is a cost associated with each debt transfer, you can ultimately save hundreds of dollars in interest.

iv. Prevent Increasing Your Daily Account Balance

Make it a goal to pay off as much of your credit card debt as possible by paying more than the required minimum whenever possible and making more frequent payments instead of once a month. Also, if you have many cards with various APRs, pay down the card with the highest interest rate first. It will save you a lot of money. Further, delay purchases, especially larger ones, and prevent your account’s daily balance from rising.

Finally, get back into the routine of paying off the entire debt on your credit card each month as soon as possible. The sooner you do that, the sooner you can stop ever having to pay interest on a credit card.

You can better manage your interest now that you know how everything works.

If you’re having trouble managing your credit card debt, contact our credit counseling expert to assist you in finding a plan of action that suits your needs.

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