How Is Credit Card Interest Compounded?
Credit card companies compound the interest on your credit card based on your average daily balance. They calculate the average daily balance by adding your new credit card purchases to your previous balance and average that out over the current month. Most credit card companies use a monthly periodic interest rate to compound the interest on your card.
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Annual Percentage Rate
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The annual percentage rate, or APR, is what the total amount of interest the credit card company charges you per year. The APR is not the amount of interest you pay every month. The APR is broken down, or divided up into 12 months.
Monthly Periodic Interest Rate
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For monthly periodic interest rate credit cards, companies compound interest every month by first dividing your APR by the number of billing cycles to get to a percentage. They then multiply your average daily balance by this percentage and charge you this amount in interest.
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Comound Interest Example
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To get a better understanding of how credit card companies calculate compound interes, here is an example: A 20 percent APR has a billing cycle of 12 months per year. To get to the monthly periodic interest rate you divide 20 percent by 12. The equation looks like this: .20 ÷ 12= .0167. If you have an average daily balance for the current month of $5,000 then the compound interest equation is: 5,000 x .0167=83.35. The compound interest for the month in this example is $83.35.
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References
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