How Minimum Payments and Credit Card Interest Are Calculated

John Ganotis

John Ganotis

Updated Jan 10, 2018

Credit cards have high interest rates compared most other types of loans. That means it’s expensive to borrow money with a credit card. When you don’t pay your full credit card balance every month, it’s easy to accumulate boatloads of interest fees quickly.

What is a credit card minimum payment? It’s the minimum a credit card company is willing to accept to keep your account in good standing.

Don’t make the mistake of thinking the minimum due is a “monthly payment” you should be paying to pay off your credit card bill. When you only pay the minimum due on your credit card statement, your credit card issuer will make a lot of extra money from you.

Your credit card statement has a minimum payment warning on it. This table shows the scary amount of interest you’ll end up paying if you only pay the minimum on your card each month.

If you don’t even pay the minimum, you’ll likely pay late fees, or worse. If you’re over a month late, the late payment may show up on your credit reports and impact your credit scores.

If you have a high outstanding balance that you can’t pay off right away, a balance transfer may help you get the debt under control. To learn about some ways to approach paying off credit card debt, skip to this page.

How much should I pay?

Credit card payments can be confusing at first. When you sign into your credit card account online, you may see several amounts:

  • statement balance: the amount you owed when your last billing cycle ended, due by the due date
  • current balance: the total amount you owe, which is usually your previous statement balance minus any payments that you’ve made since it was generated, plus any new purchases you’ve made since your last statement was generated
  • minimum due: a minimum monthly payment your credit card company is willing to accept to not mark your account as “past due”

We recommend you pay the entire statement balance by the due date every month. That way, you’ll avoid credit card debt and interest. Most credit card companies let you connect checking accounts to set up automatic payments. This makes it easy to pay the full statement balance each month. Just remember to review your statement to check for fraud or billing errors. We cover avoiding interest more on the next page.

Even though your current balance may be more than your statement balance, most credit cards have a grace period on new purchases. That means you don’t have to pay interest on new purchases until the statement is due for the billing period when you made the purchase. Some people choose to pay more than the statement balance to reduce credit card utilization, which is a big factor in credit scores.

If you’re confused about these different amounts, check out our example of how paying a credit card bill works.

How is my minimum payment calculated?

The exact way your bank calculates minimum payments depends on the terms of your card. It can vary from one card to the next. Here’s an example of how the minimum payment calculation might be written on your card’s terms:

Minimum Due is calculated as 2% of the Statement Balance rounded down to the nearest $1. When the Statement Balance is above $15, the Minimum Due will be no less than $15.

There’s usually a minimum amount (like $15 or $25) for the Minimum Due when your balance is at least that high. Minimum due amounts also usually round to the nearest dollar or $5.

If you can’t find a copy of the terms for your card online and don’t still have the copy that came with your card in the mail, you can usually find out how the minimum is calculated by calling the phone number on the back of your card.

Why is it so bad to only pay the minimum monthly payment?

Here’s an example to show why only making the minimum payment (or close to the minimum payment) can keep you in credit card debt for many years.

Let’s say you have a credit card with an 18% APR (annual percentage rate), your balance is $10,000, and the terms of the card say the minimum payment is 2%.

Keeping the numbers simple, we can approximate your first month’s interest charge is $150: $10,000 balance x (.18 APR / 12 months) = $150, so now you actually owe $10,150. 2% of that is $203, so your minimum payment is $203.

If you only pay the minimum of $203, most of that ($150, or  around 75%) is just going toward paying interest you accumulated over the past month. Even though you’re paying $203 to the credit card company, you’re really only paying $53 toward the balance you owed at the end of the previous billing cycle.

Some credit cards have APRs in the neighborhood of 24%. If you repeat this same example using that higher APR, the monthly interest is $200. Since the interest is the same as the minimum payment all of the payment is going to paying interest.

Think about how depressing that would be over the course of a year: you paid the credit card company $2,400 ($200 x 12 months) and you still owe the same amount you did a year ago.

If you were to increase the amount of debt in this same example, more credit card debt would accumulate each month because the minimum payment would not even cover the additional interest being added each month. You would be deeper in debt each month even though you’re paying the minimum.

You’ll pay interest on interest you owe

With most credit cards, every time you carry a balance from one billing cycle to the next you’ll be charged interest on the amount that wasn’t paid off yet. Even if you pay more than the minimum, as long as you’re paying less than the statement balance, this debt will multiply.

When you’re charged an interest fee, it’s added to your balance. If you carry any of that balance into the next billing cycle, you’ll be charged interest on the remaining balance, including the interest the credit card company added to your bill last month!

This is called “compounding” — you’re charged interest on the entire amount you owe, including any interest owed, every time interest is calculated. This is why it can feel like credit card debt quickly snowballs into larger and larger amounts, and why it’s hard to make a dent in it.

Even though an APR appears to be an annual interest rate, credit card interest is compounded more frequently, not just at the end of the year. Depending on how your credit card calculates interest, you may owe more money every day you carry a balance, not just every billing cycle.

How are finance charges calculated?

There are several different methods credit card companies use to calculate interest. To find out exactly how interest is calculated on your credit card, read your cardholder agreement. If you don’t have the documents that came with your card, you can usually request a new one by calling the phone number on the back of your card.

Daily Balance Method

One common method for calculating interest is the daily balance method. With this method, interest is calculated based on your balance on each individual day in your billing period.

Interest can be compounded either daily or monthly with this method, depending on the terms of your card.

If it’s compounded monthly, the balance each day is multiplied by a daily interest rate. At the end of the billing cycle, these daily amounts are added up to result in your finance charge.

If it’s compounded daily, the interest is calculated and added to the balance each day, and then that balance is used for interest calculation the next day. This results in higher interest payments than when your interest is compounded monthly.

With both of these methods you’re effectively accumulating more interest every day that you carry a balance beyond your credit card’s grace period. If it’s compounded daily, you’re paying more interest on top of any interest you already owed the day before.

Here’s an example of the Daily Balance method with interest that compounds daily:

Since an APR is an annual rate, your credit card issuer will divide that number by 365 (or 360, as some issuers use) to determine a daily interest rate. If your APR is 18%, for example, the daily rate would be 0.0493% (.18/365 = 0.000493). This is known an the daily periodic rate or DPR.

Let’s say you have a $1,000 balance on your credit card that you carried over from the previous statement period.

On the first day you owe interest, the issuer will multiply your balance ($1,000) by the daily rate (0.0493%) to determine your interest charges ($0.49). Those interest charges are added to your balance, so you now owe $1,000.49.

The next day, they’ll do the same thing: multiply your balance (now $1,000.49) by the daily rate (0.0493%) to determine your interest charges ($0.49). Now you’ll owe $1,000.98.

On the next day, they’ll do the same thing again: multiply your balance (now $1,000.98) by the daily rate (0.0493%) to determine your interest charges ($0.49). Now you’ll owe $1,001.47.

At the end of the 30th day, you’ll owe $1,014.40, so you’re paying a total finance charge of $14.40 for the billing cycle.

Since we only followed this example for a few days, the amount of additional interest owed each day does not appear to change since it’s only increasing by fractions of a cent. However, over time, the amount you owe can snowball, because every day you don’t pay down your balance you are owing more interest on the balance (including interest that compounded on previous days).

Average Daily Balance Method

Other credit card issuers use a method called Average Daily Balance for calculating interest instead of the Daily Balance Method. That means they’ll average together your balance every day of the month, then multiply that by the daily rate and the number of days at the end of the billing cycle.

Let’s say you have a $500 balance entering the month, then pay $500 on the 16th day of a 30 day month. For the first 15 days of the month, your balance is $500. For the second half of the month, your balance is $0.

With this method, the balance on each day is added up, then divided by the number of days in the billing cycle:

(Day 1 Balance + Day 2 Balance + Day 3 Balance…Day 28 Balance + Day 29 Balance + Day 30 Balance) / number of days

If you do this math with a $500 balance for the first 15 days and a $0 balance for the last 15 days, you end up with an average daily balance of $250.

To calculate your interest fees for the month, your credit card issuer multiplies the average daily balance by the number of days by that daily rate of 0.0493%. In this example, when we multiply $250 x 30 x 0.0493%, the interest charge ends up being $3.70.

Notice how in this example your balance is $0 at the end of the billing cycle, which makes it looks like you’ve paid off all your debt, but you still had a $3.70 interest charge. This is residual interest. We’ll discuss this more in a moment.

Adjusted Balance Method

This method is much simpler to calculate, and can result in lower interest than the previous methods discussed, but it’s rarely used by credit card issuers.

With this method, you start with the balance at the beginning of your billing cycle, then subtract any payments you made during the billing cycle. Since there’s a grace period on new purchases, those aren’t added.

The resulting amount is multiplied by a periodic interest rate based on the APR and the number of days of the billing cycle to calculate the finance charge.

For example, let’s say the balance left over from your previous statement cycle was $1000, and some time during the month (it doesn’t matter when) you made a $500 payment. Now, there’s $500 left. Assuming the same 18% APR we’ve been using, the interest rate for a 30 day billing cycle is 1.5%: 0.18/12 = 0.015

$500 x 1.5% = $7.50, so your interest charge is $7.50, regardless of when you make a payment, as long as you made $500 in total payments throughout the month.

Residual Interest and Timing of Payments

With the Daily Balance and Average Daily Balance methods, you can end up with something called “residual interest.” This happens when you’ve already paid off your entire credit card bill after carrying a balance for a few months, but then you see an interest charge on your next statement.

This is exactly what’s being illustrated in the Average Daily Balance method above: Even though the balance was $0 at the end of the statement period, there was a finance charge. This finance charge on your next statement after paying off a card is the residual interest. It’s the interest that accumulated on those days in the first half of the month when you were still carrying a balance, before you paid it off.

When interest is calculated with the Average Daily Balance method or Daily Balance method and you are carrying a balance, the day you choose to make a payment during your billing cycle matters. Ignoring additional purchases, if you make a payment earlier in your billing cycle, you’ll end up paying less in interest than if you make a payment later in the billing cycle. This is because your balance will be lower for more days of the cycle.

Looking at the same Average Daily Balance example as above, let’s move the payment to a different day and see how the interest charge changes.

If there’s a $500 balance entering a 30-day billing cycle, then you pay $500 on the 9th day, the balance is $500 for 9 days, then $0 for 21 days. This results in an average daily balance of $150, so your finance charge is only $2.22 instead of $3.70: $150 x 30 x 0.0493% = $2.22

In the same situation, let’s say you pay on the 21st day instead. The balance is $500 for 21 days, then $0 for 9 days. This results in an average daily balance of $350, so the finance charge is $5.18 instead of $3.70: $350 x 30 x 0.0493% = $5.18

Although the numbers aren’t very big in this example, it illustrates how you could end up paying a lot more in interest when you have high balances and you pay off debt later in a billing cycle.

Variable APRs and How Your APR Can Change

There are a few ways your APR can change. Based on these examples, you can now see how even a slight increase in APR could instantly start costing you more money if you’re carrying a balance.

Changes to the Prime Rate

First, almost all credit cards have variable APRs. These APRs are tied to the Prime Rate. The Prime Rate is 3 percentage points higher than the federal funds rate, which is a rate set and changed by the Federal Open Market Committee, an organization within the Federal Reserve system.

The Federal Open Market Committee meets periodically throughout the year to decide whether they should change the rate or keep it the same. If they decide to increase it by 0.25%, for example, the APRs on credit cards with variable APRs will go up by 0.25%. If you’re carrying big balances on credit cards, you’ll see your interest fees go up slightly even if your balance is the same.

Unless you’re on the FOMC, fed rate changes are out of your control. Instead, focus on paying your credit cards off in full each month so you can avoid carrying a balance and the interest that goes along with that.

For more context on how the Prime Rate and the U.S. economy work, watch this video.

Changes to Your Credit History

The APRs of your credit cards are often set based on your credit history. Generally, the better your credit history is the lower your APRs will be. If your creditworthiness changes, your credit card issuer may change the rate.

If you start making late payments or go over your credit limit, for example, your credit card issuer may raise your APR. There is often a Penalty APR that is much higher than the regular APR, and can be triggered based on specific actions according to the terms of your card.

Due to the CARD Act of 2009, credit card companies aren’t allowed to change your APR on existing balances. However, they can change the APR for any new balances going forward. So, a penalty APR won’t apply to an amount you already owe, but will apply to future charges to the card.

Credit card issuers will periodically check your credit history. Even if you have not missed a payment on a specific card, that issuer may see that you’re missing payments on other cards and choose to increase your APR going forward.

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