Daily Interest Rate
Different transactions often have different interest rates. For example, you might have a regular rate for purchases, a higher rate for cash advances, a lower rate for balance transfers and a no-interest rate for six months. Although interest rates are quoted in annual terms, most lenders charge interest on a daily basis. To convert an annual percentage rate, or APR, to a daily rate, divide the APR by either 365 or 360, depending on your lender's policy. For example, if an interest rate is 10 percent, divide 10 percent by 365 to get 0.0274 percent, or 0.000274.
Balance Used for Interest Calculation
The terms and conditions of your credit card explain exactly how your finance charge is calculated. While a lender must consistently apply the same method to calculate your finance charge, there are five permissible ways for credit card companies to determine your balance and calculate your interest charge:
- Calculate your actual balance each day,
- Calculate the average of your actual balance each day in your billing period,
- Use the closing balance on the last day of the billing period,
- Use the closing balance on the last day of the prior billing period, or
- Use the closing balance on the last day of the prior billing period minus any payments you made.
Computing the Finance Charge
If your credit card company uses the actual daily balance, your finance charge is the sum of the daily interest rate times the daily balance for each day in your billing cycle. The finance charge for the other methods is the balance times the daily interest rate times the number of days in your billing cycle. If purchases and cash advances have two different interest rates, you must track the balances and calculate the finance charges separately for each type of transaction and then add the individual charges to determine the total amount you owe.
Suppose your balance for purchases is $500 at 8 percent interest using 365 days for a year; your balance for cash advances is $100 at 14 percent; and there are 25 days in your billing cycle. To calculate your finance charge, take 8 percent and divide it by 365 to get a daily interest rate of .00022. Multiply that by $500 to get 11 cents interest per day, and multiply that by 25 days to get $2.75. Next, take 14 percent and divide it by 365 to get .000384. Multiply that by $100 to get 3.8 cents per day, and multiply that by 25 days to get 95 cents. Add $3.30 and 95 cents to determine your total finance charge of $4.25.
Cash Advance Transaction Fees
Depending on the amount of time it takes you to pay off the cash withdrawal balance, the fee your credit card company charges when you take a cash advance can grow substantially. For example, if you took a $100 cash withdrawal and your lender charged a 5 percent transaction fee, or $5, it's the same as if you had taken a $105 cash advance. The fee is added to your daily balance, and you pay interest on the fee every month until you pay off the cash advance balance.