Interest rates can be a big nuisance to our finances. It would sure be nice if everyone was required to know how to calculate interest in order to graduate high school. It would save us thousands of dollars and eliminate tons of financial stress. But unfortunately, most of us learn the answer the hard way. We learn this when it’s too late. After racking up thousands of dollars in credit card debt, we understand that interest rates serve as a major roadblock on our journey to paying back our debt.

What is credit card interest?

Simply put, it’s the price we pay for borrowing money. Think of it as a fee you pay for having debt. Or the punishment for spending money you don’t have. Each credit card has an interest rate or annual percentage rate (APR). And in some cases, you may have multiple APRs. One for purchases, one for cash advances and perhaps one for balance transfers.

How does interest get calculated on a credit card?

Here’s the complicated part for those that hate math. The interest is calculated daily but appears on your statement as a monthly finance charge. You typically have 12 different statement periods each year. With 365 days in a year (or 366 every four years), each period varies on the number of days in it. Some can have 30 and some may have 31. Therefore, your finance charges will vary from month to month especially with your balances going up and down.

It's very important to keep track of your APRs on your cards and to know what your monthly finance charge is each month. Because each time you make a monthly payment, you need to know how much of that goes toward interest. The higher the interest is, then it’s more likely that most of your payment is going toward just interest. This scenario makes it difficult to pay off your debt.

Example of calculating finance charges on credit card debt

Let’s take an example of someone who has $20,000 of credit card debt with an APR of 24%. To calculate their monthly finance charge, let’s convert their APR into a daily rate. 24% divided by 365 comes out to a daily rate of .065%. Next, multiply the $20K by .065. This comes out to $13. Then take that $13 and multiply it by 30 days (assuming your statement period is 30 days). We get $390 as the total monthly finance charge.

Now look at the monthly payment that you normally send. Let’s say it’s $500. Each time you send $500, the bank takes $390 in fees and only $110 goes toward the balance. It’s quite painful to see but can motivate positive change for some.

How can you lower your rates on credit cards?

The most popular ways to lower interest rates are through a debt consolidation loan, balance transfer, hardship programs offered directly by the creditors or credit counseling. Be sure to understand the pros and cons of each credit card consolidation service.

What do interest rates, credit scores and net worth have in common?

They are all very important numbers in personal finance. They also require some intimidating math or formulas in order to get the final result. The more time you can spend understanding these numbers, the better off your personal finances will be.