How credit card interest is calculated: APR, daily rate and average daily balance

The three numbers that set your interest charge

The CFPB explains that many issuers calculate interest daily, based on your average daily balance, and that the daily charge is called the daily periodic rate. Three numbers produce the interest line on your statement: the APR, the number of days the issuer divides it by, and the average of your balance across the days in the billing cycle. Your cardholder agreement names the balance method and the divisor; check it before you rely on the example below.

Because interest accrues daily, the CFPB notes that paying down some or all of a balance sooner reduces the interest you pay. A payment on day 5 of the cycle lowers more days of balance than the same payment on day 25.

Worked example: one billing cycle with a carried balance

The figures are invented. A card has a 24.00% purchase APR. The daily periodic rate is 24.00% / 365 = 0.065753% a day. Last month Riley paid only part of the bill, so $1,000 is carried into a 30-day cycle and, under this agreement, there is no grace period on new purchases this cycle.

Days 1 to 10 the balance is $1,000. On day 11 Riley buys $500 of furniture, so days 11 to 20 the balance is $1,500. On day 21 Riley pays $300, so days 21 to 30 the balance is $1,200. The average daily balance is (10 x $1,000 + 10 x $1,500 + 10 x $1,200) / 30 = $37,000 / 30 = $1,233.33.

Interest for the cycle is $1,233.33 x 0.00065753 x 30 = $24.33. Had Riley paid the $300 on day 1 instead of day 21, the balance on days 1 to 10 would have been $700 and days 11 to 20 $1,200, giving an average daily balance of $1,033.33 and interest of $20.38: about $3.95 saved by paying 20 days earlier.

How the grace period works and how you lose it

The CFPB says most cards provide a grace period on purchases, though issuers are not required to offer one, and that if you pay the full balance by the due date you avoid interest on purchases. Issuers must send the bill at least 21 days before the payment is due. If you lose the grace period by not paying in full, you owe interest on the unpaid amount and new purchases start accruing interest from the day they are made.

In the example, if Riley had paid the previous statement in full, the $500 purchase would have cost nothing as long as the next statement was also paid in full by its due date. Instead, it accrued interest from day 11. That is why carrying even a small balance can make every new purchase more expensive. Your agreement says what it takes to restore the grace period; read that clause if you are paying a balance down.

Regulation Z section 1026.54 limits what an issuer can do when the grace period is lost. It may not charge interest on balances from days in billing cycles before the most recent one, which bans the old two-cycle billing method, and it may not charge interest on any part of a grace-period balance you repaid before the grace period ended.

Check your own statement in five steps

• Find the purchase APR and the interest charge for the cycle on your statement.
• Divide the APR by the number of days your agreement uses for the year to get the daily periodic rate.
• Find the average daily balance on the statement, or list each day's balance from the transaction dates and average them.
• Multiply average daily balance x daily periodic rate x days in the cycle and compare with the statement. A small difference can come from compounding or rounding; a large one is worth a call to the issuer.
• Repeat separately for cash advances and balance transfers, which can carry different APRs and usually no grace period for cash advances.

What this means for your payments

If you can pay in full, do it by the due date every month and purchases cost no interest. If you cannot, pay as early in the cycle as you can and stop putting new purchases on the card that carries the balance, since they no longer get a grace period. Compare the cost against our minimum-payment guide to see how long a balance lasts at the minimum, and against a balance transfer or a deferred-interest offer only after reading those guides' fine print.