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How interest is calculated

If you buy something with a credit card, you are borrowing money from your card company to pay for it. Interest is the cost of borrowing this money.

If you don’t repay the amount you owe in full by the payment due date, your card company will charge you interest.

The interest rate is a way of expressing this for a set time-period, usually a year and is always expressed as a percentage of the amount borrowed.

Do not confuse the interest rate with the annual percentage rate (APR).

The underlying calculation method

When your card company calculates the interest you owe it uses either the average daily balance method or the daily balance method. Although the two methods differ in their way of calculating interest they generally result in the same interest charge.

Average daily balance method

The average daily balance on your credit card is the balance you carried during your statement period, averaged by the number of days in the statement period (usually 30 or 31).

Daily balance method

Where the average daily balance method only makes a month-end calculation of the interest owed, the daily balance method calculates interest owed at the end of each day of the billing period.

The length of the interest free period

You usually benefit from an interest-free period when you buy something with your credit card, as the card company doesn’t start charging you interest on your purchases right away.

In other words, you get credit without having to pay for it, making credit cards very cost-effective. However, unless you pay in full every month the interest-free period does not always apply to new purchases.

The interest-free period has two parts:

  • The time between the purchase and your statement date
  • The time between your statement date and your payment due date.

The maximum length of the interest free period is shown in the summary box, and only applies if certain conditions are met.

Interest is normally charged immediately on transactions such as cash advances, credit card cheques or balance transfers. This is because you are effectively borrowing cash from the moment it is withdrawn or the balance is transferred.

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