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Understanding how credit card interest is calculated might sound as exciting as watching paint dry, but it can help you gain a better idea not only of how much your credit card balances are costing you, but also of how your credit card payments can change over time. That might not seem important on its face, but if you routinely carry balances, knowing exactly how your issuers are calculating interest can help a lot in determining which bills to pay off first.
APR Vs. DPR
Many credit card issuers use what’s referred to as a daily periodic rate, or DPR, to calculate interest on your balances. The formula for DPR is pretty straightforward: It’s your annual periodic rate, or APR, divided by 365, the number of days in the year.
If you don’t know your APR, you can find it in the fine print on your monthly statement, on your issuer’s website in what’s referred to in industry terms as the Schumer Box, which essentially outlines your card terms and conditions in an easy-to-read format.
Say, for example, your APR is 14.9%. You’d divide that by 365, coming up with a DPR of 0.0004. Most credit cards don’t just apply that to the balance you carry each and every day, however. They use what is called “average daily balance” to simplify the process.
Let’s say you started the month with a $200 balance and have a 28-day billing cycle. You made a $150 purchase on day 10 of your billing cycle, plus another $150 purchase on day 20, ending up with a $500 balance. Here’s how you’d calculate your average daily balance:
- Day 1-9: $200
- Day 10-19: $350
- Day 20-28: $500
- ($200 x 9) + ($350 x 10) + ($500 x 9) / 28 = ($1,800) + ($3,500) + ($4,500) / 28 = $9,800 / 28 = $350
Now the DPR is applied. At 0.0004 x $350, that’s 14 cents per day. Multiplied by the number of days in your billing cycle, 28, that’s $3.92 in interest charges for the month.
As you can see, your monthly interest charges can begin to add up the higher your balance becomes and the longer you carry it.
“The process above allows you to see how this charge is determined and reveals why multiple payments in a single month can help reduce this charge (due to lower average daily balance),” said Thomas Nitzsche, a credit educator with ClearPoint Credit Counseling Solutions.
How to Stop Carrying a Balance
If you’re in a cycle of paying just your minimum balance and never seem to get your balances down, there are several approaches you can take.
1. Transfer Your Balances
First, you could look into transferring your balance or balances to a new card with a 0% interest rate, which could help you pay off the card without making those monthly interest payments. Of course, most cards with a 0% introductory interest rate charge a fee for the balance transfer — usually 3 to 5% of the total balance — so it’s good to calculate whether such a decision would actually save you money.
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2. Pay Off Your Highest Interest Card First
If transferring your balance to a new card isn’t an option — say your credit isn’t in good enough shape to qualify for another credit card — you could look at paying off your credit card with the highest APR by increasing your monthly payments to that card while just making minimum payments on the rest. (You can check your two free credit scores at Credit.com.) Once that card is paid off in full, it’s time to start on the card with the next highest APR, and so on and so forth.
This strategy can make good sense because it quickly whittles away at the interest payments you’re making. You can see how long this process will take by using this credit card payoff calculator.
3. Pay Off Your Lowest Balance First
Of course, there’s a similar plan that allows you to pay off your credit card with the lowest balance first. If you need to see results quickly in order to stick with a plan, this could be a good option for you. With this strategy, you increase payments to the card with the lowest balance, maintaining minimum payments on your other cards. Once you’ve paid off that balance, you move to the card with the next lowest balance.
4. Get a Debt Consolidation Loan
Debt consolidation can be helpful if you’re struggling to make multiple payments each month. You’ll have just one payment to make and you’ll likely have a lower interest rate as well. But paying the debt off as quickly as possible is still important because it’s still costing you money each and every day it sits there, so make an effort to pay it off quickly, making more than just the minimum payment if possible.