# How Interest Accrues on Credit Cards

If at all possible, pay off your credit cards every month.  If that isn’t feasible, then make sure to only use those cards with lower APR.  Having to pay 20% or more interest on purchases greatly increases the final cost of those items.  If you have to use a credit card with a high interest rate, make sure to make a payment well before the due date.  Never wait until the last day, or your interest will always be higher than it needs to be.

The thing to keep in mind about how banks charge interest on credit cards is that they use average daily balances.  That means it doesn’t matter how much money is on the card when the interest is posted, but rather the average amount that was on it during the month.

Every credit card gives the user a due date. If the total balance is paid by that date, then no interest is added.  On the other hand if only a portion of the balance is paid on the actual due date, then interest is applied on the entire amount.  It doesn’t matter if the previous balance is \$2,000 and \$1950 is paid on the date it’s due, interest will be applied on the entire amount, not the \$50 balance.  Doesn’t seem fair? Well, it’s not, but it’s something you agree to when you use the card.

If payment was made half way through the monthly cycle, then the interest will only apply to about half the amount.  The reason for this is that the interest is based on the average daily balance, which is multiplied by a fraction of the APR. What does that mean?  There are 365 days in a year.  If the APR is 20%, then the daily APR is .05479%, which is 20% divided by 365.

Whatever the average daily balance is for each day of the cycle, it is multiplied by .0005479.  This happens every day for 30 days and then all the amounts are added together.  The final amount is what is posted on your credit card statement as interest due.

Let’s say you make a purchase on September 1st for \$2,000 and your APR is 20%.  For simplicity, let’s say your due date is October 1st.  If you make a payment of \$1,500 on September 20th, your interest for the month will be \$24.66.  Now, let’s break down how I came to that figure.

\$2,000 X .0005479 X 20 days = \$21.92

\$500 X .0005479 X 10 days = \$2.74

What would the interest have been if you had made that payment on the 10th of September instead of the 20th?  It would have been \$16.44.

\$2,000 X .0005479 X 10 days = \$10.96

\$500 X .0005479 X 20 days = \$5.48

And what would it have been had you waited until the actual due date?  It would have been the highly inflated amount of \$32.87.

\$2,000 X .0005479 X 30 days = \$32.87

So you can tell by the above examples how important it is to pay off monthly balances or to at least make payments as early as possible and not wait until the actual due date.