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How does the interest rate on a credit card work?

Curious about Plastic Money

How does the interest rate on a credit card work?

The interest rate on a credit card represents the cost of borrowing money from the issuer of the credit card. If you carry a balance on your credit card, you will be charged interest on that balance, and the interest rate will be expressed as an annual percentage rate (APR).

Credit card issuers typically use a variable interest rate, which means that the interest rate can change over time. The interest rate is usually tied to a benchmark rate, such as the prime rate, and can vary depending on market conditions, the creditworthiness of the borrower, and other factors.

If you pay off your credit card balance in full each month, you will not be charged interest on your purchases. However, if you carry a balance from one month to the next, you will be charged interest on that balance, and the interest will compound daily. This means that interest will be added to your balance each day, and that interest will then earn interest itself, resulting in an increasing balance over time.

To calculate the amount of interest you will be charged on your credit card balance, you can use the following formula:

Interest = Average Daily Balance x Daily Interest Rate x Number of Days in Billing Cycle

The daily interest rate is calculated by dividing the APR by 365 (or 360, depending on the issuer). The average daily balance is calculated by adding up the balances on each day of the billing cycle and dividing by the number of days in the cycle. The number of days in the billing cycle varies by issuer, but is typically around 30 days.

It is important to pay close attention to the interest rate on your credit card and to avoid carrying a balance if possible, as the interest charges can quickly add up and lead to a significant amount of debt.

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