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How do Banks Calculate Credit Card Interest Rate?
Using credit cards is one of the most convenient things of life for us. But it is the interest rates applied on these cards that spoil all the fun, isn’t it. Well, anything that is convenient comes for a price so there is no escaping interest on credit cards. Though you cannot do anything about the interest, you may want to know how the credit companies or banks calculate credit card interest rate.
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How Banks Calculate Credit Card Interest Rate
The credit card companies and banks calculate credit card interest rate on a daily basis but it is reflected as a total amount on your monthly credit card bill. The billing cycle of all credit cards is 1 month and usually begins from 11th of one month to 10th of next. First of all the ADB or average daily balance that is outstanding during each billing cycle is calculated.
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For doing this the bank will have to calculate the ending balance at the close of every single day in the billing cycle for all kinds of transactions carried out with the credit card. After totaling the daily ending balance it is then divided by the number of days in the billing cycle. Following this, they further proceed to calculate credit card interest rate for each day by dividing the APR by total number of days in a year, which is 365. Finally the ADB is multiplied by daily rate and then multiplied by the number of days in the billing cycle. (See How to Calculate Annual Percentage Rate APR - Find Cheapest Credit Card, Comparing Credit Card Offers, Cutting your Interest Rate and APR)
So, daily rate of interest on your credit card= APR/ 365. If your credit card charges you an APR of 18.75 % then you can calculate credit card interest rate by this formula- 18.75/ 365= 0.051
Is There an Interest Free Period?
It is a big benefit to have an interest free period allotted on your credit card usage. Usually this is a period of 30 days of the billing cycle plus another 25 days that are allotted to you from the end of the billing cycle to the due date. If you manage to pay the complete amount outstanding on your bill on or before this closing date, you will not be charged any interest at all. But miss this date by even a single day and the banks will begin to calculate credit card interest rate for each day that you delay the payment.
In case you pay the entire amount a few days after the closing date but before the next due date, it does not help in waiving the late payment charges. You will not only lose all benefits of an interest free period but also this late payment can show up as a negative remark on your credit score as well.
Synopsis
Banks calculate credit card interest rate on all kinds of transactions done against the credit card in a particular billing cycle like shopping, cash advances etc. But interest rates for cash advances will be different than those charged for shopping. So the actual interest that you will be charged in each billing cycle will depend upon the kind of transactions you have made against the card.
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