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Current time:0:00Total duration:7:14

How credit card interest is calculated

Video transcript

let's think a little bit deeper about how interest on your credit card is actually calculated forgiven billing cycle and a billing cycle is just a period of time over which the credit card company will give you a statement and so let's just say for the sake of argument all your billing cycle is from the first of the month to until the first of the next month and we'll just assume that it's October to use as an example so let's just say going into October you had $100 balance on your credit card so you have $100 balance on your credit card and you continue to have $100 balance you don't do any spending nor do you pay down the card until October 6 so let's say that's the sixth right over there and that's where you go and you buy yourself a nice sweater $400 and so now now you have a $200 balance on your credit card and once again that $200 balance it continues you don't do any more spending or paying down but you had sent a check in a couple of days ago and it finally gets registered with the credit card company on the 20th and that check was for $150 and so it pays down your balance your balances now would now go down from 200 since you paid 150 it would go down to 50 it would go down to 50 and then you don't eat you don't do any more paying nor do you do any more spending until the end of the billing cycle just like that so let's think about how much interest you would have to pay for that period and just for just to make things a little bit concrete let's say that your annual percentage rate APR it's typically called let's say that that is twenty two point nine nine percent I just looked at one of my credit cards and that is what the APR was and they always tend to put this point nine nine percent I guess they feel like it makes you look it looks better than saying twenty three percent so let's think about what your the interest charge would be for the spending in this period and the way that it's typically calculated is using the average daily balance method so let me write this down average daily balance and one way of thinking about it is it is exactly what it says it is your daily balance for every day in the billing period so for example right over here we had five days from October 1st until the beginning I guess you could say from midnight October 1st until midnight October 6th where we had a balance of $100 so we could write that down we have 5 days where we had a balance of let me write like this we have 5 days where we had a balance of $100 and then we go from the 6th to the 20th so that is 14 days when we have a balance of $200 so plus 14 times $200 and then finally going from the 20th to the 1st you could almost see the first as xxxii so this is another this right over here would be 12 days this is going to be 12 days where we have a balance of $50 and we're going to divide this we're going to divide this by the total number days of our billing cycle and once again in October we had 31 days 31 days this would be a different number if we were going from the 1st of February to the 1st of March and just to make it clear that this is the average daily balance I could have written down 100 plus 100 plus 100 5 times so I could have done 100 plus 100 plus 100 plus 100 5 times and then I could have done 200 plus 200 plus 200 so literally for each day that I met 100 I would have written 100 but there's 5 of those and for each day that I meant 200 I could have added 200 to this to the top part of this fraction here but this 14 of those who I just multiplied 14 times 200 and same thing there are 12 days when I was at 50 I could have said 50 + 50 + 50 done that 12 times but that's just going to be 12 times 50 so our average daily balance is going to be let's think about this this would be $500 14 times 200 is 2,800 or two thousand eight hundred and then 12 times 50 is six hundred dollars so let's see five hundred plus six hundred is eleven hundred plus twenty eight hundred is three thousand nine hundred dollars and we're going to divide that into 31 so if you summed up your balance for each day you would get 3,900 and so let's divide so $3,900 divided by 31 gets us a hundred and twenty five point eight I guess if we round to the nearest any eight $1 so that is equal to give myself some space here one hundred and twenty-five dollar one hundred twenty five point eight $1.00 $125 and 81 cents this is what your average daily balance would be now your credit card company based on this can actually calculate what your interest charge should be for that billing cycle so they'll take one hundred and twenty five dollars and 81 cents and then they're going to multiply it by your APR but adjusted for the number of days in the billing cycle so you'll say what fraction of the year was this billing cycle so they'll multiply it so let's assume that there were 365 days in this year this billing cycle has 31 days so 31 divided by 365 and then that times the annual percentage rate so times 22 point nine nine percent and that is going to give us get the calculator out again and so I can take this previous answer that I had and multiply that that just means the previous answer that I just had times 31 divided by 365 times 22 point nine nine percent that's the same thing is zero point two two nine nine and we get an interest charge of two dollars I guess we say two dollars and forty six cents so two dollars and forty six cents in interest now if we pay the entire that's what that's what we'll have to pay an interest if we don't pay the entire balance off in full but you usually and have a grace period great so that if you pay your credit card fully often and the grace period only applies for tradish for credit transactions not necessarily things like cash advances or not necessarily things like balance transfers but it's typically you have a grace period of 21 to 25 days sometimes it might be even longer than that where if you pay off your balance in that period so in the grace period grace period so if you completely pay this off so if you pay off the $50.00 in this period then you won't have to pay this if you pay anything less than the complete balance then some of your payment will go to this interest charge
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