Credit is the most popular form of transaction among the consumption-oriented modern spenders. It's easy to handle, tailor-made for our wallets, and lends us that extra punch of confidence while spending. A total of 220 million credit cards were in circulation by the end of the year 2017. Nevertheless, an average credit card user has very limited knowledge about how exactly the interest on a credit card is calculated.
You might be thinking that your credit card already comes with the details regarding the annual rate of interest (known as Annual Percentage Rate or APR) chargeable, but that isn't exactly how the interest rate on your credit card is calculated. So, if the APR on your credit card is 12%, then the interest charged wouldn't be exactly 12%.
The calculation of interest generally takes your DPR or Daily Periodic Rate into consideration. DPR is calculated by dividing APR by 365, which is the number of days the card is active during a year.
Here's an overview of how you can calculate the actual interest on your credit card:
Calculate Your DPR
The DPR can be easily calculated by dividing the annual percentage rate (APR) by 365. Let's say that your APR is 9%, then your daily periodic rate would be 9/365=0.025% approximately.
Know What Your Average Daily Balance Is
Your Average Daily Balance is another factor which the interest on credit cards depends upon. You can start off by finding out your daily balance, which is the amount that remains unpaid on a particular date. When you're making a purchase, the daily balance goes up; when you're making payments due on your credit card, your daily balance goes down. Suppose you have an unpaid balance of Rs.500 everyday for the month of March. Your average daily balance is calculated by dividing the cumulative amount for the month by the number of days, i.e., 31.
Therefore, Average Daily Balance for the month of March = (500*31)/31=500
Add It Up
Finally, you need to multiply your daily periodic rate to your average daily balance, and the total amount is multiplied by the number of days in the billing period. So, if your billing period is 365 days, the DPR is 0.025%, and Average Daily Balance is Rs.500, at the end of the year, you'll be paying around Rs.4562.
Credit card users are charged interest only when they carry a credit balance from one month to another. So, if you're paying your credit card bills on time, you wouldn't have to pay any interest at all.
If you fail to make your credit card payments on time, take a credit card which has a low interest rate to save up.
So, now you know that the interest on credit card bill fluctuates around the stipulated interest rate. One way of reducing the interest on your credit card bill is to make payments multiple times over the billing period. That way, your average daily balance will reduce and you'll end up end up paying lesser interest compared to the stipulated interest rate on the credit card.
If you make your credit card payments more frequently then your credit score will improve.
If you're someone who wishes to reduce his/her interest on the credit card bill, then you can make the payments more than once in a month in order to bring down the average daily balance. Another way of reducing the interest is to look for a special credit card for your purchases so that you can avail several rewards as well.
However, if you fail to make the payment on time, you must pay more than the minimum amount so that you're charged a lower level of interest.
Now that you understand how the interest on your credit card works, you're capable of making better financial decisions.
However, the only way to avoid falling into a debt trap is to make your credit card bill payments on time! Check your credit score regularly as well, so that you can make sure that things are under control.