With how much we spend on average each year, you would think money itself wouldn’t be complicated. Maybe it wouldn’t be, if we only ever bought what we could afford and never borrowed money from friends or the bank. We borrow from the bank quite frequently, however. You know this if you own and regularly use a credit card.
You don’t have to continue to wonder how much you might have to pay back each time you borrow money using your credit card. The way to calculate what you will owe based upon the amount you spent, and an interest rate, is fairly easy to calculate once it’s broken down.
Learn how to calculate your credit card interest so you can keep your debt in check. Also learn a little secret on how to remain debt-free (it’s a great tip).
What is credit card interest and how does it accumulate?
You might be wondering how people go into debt in the first place. After all, if there isn’t any money to spend, how does a person go into the negative? Debt comes from borrowing money. If you borrow money from a friend, you are in debt to them until you pay them back. It’s the same idea when you purchase something using a credit card. This is different from a debit card, in which you can only make purchases using money from a bank account.
When you use a credit card to make a purchase, you are pretty much committing to pay back money you don’t actually have. How long it takes to pay back that amount depends on how much you are willing and able to pay per month. The catch is that the longer it takes you to pay off your debt, the more you will end up paying.
This is because of interest, which is an amount calculated with your monthly credit card payment that you are expected to pay in exchange for borrowing money. Depending on your specific credit card and factors such as credit score, you will have to pay a specific percentage of interest per month until you pay off your debt if you are ever carrying charges on your card. Unfortunately, this means that if you take a long time to pay off your credit card, you might end up paying more in the long run than you originally did to make your purchase.
So in a nutshell, you will spend fewer dollars in interest over a shorter period of time the more quickly you pay off the money you owe. So if you have credit card debt and you can afford to pay off more than the minimum monthly payment requirement over time, you will eventually end up saving a lot of money.
How to calculate credit card interest
As stated above, each credit card company charges a different minimum interest percentage. However, to help you better understand how to calculate credit card interest, we will use a straightforward example borrowed from Investopedia to explain, in as realistic terms as possible, how credit card interest is calculated.
Let’s say you owe $2,000 on your credit card. Your card requires you to make minimum monthly payments at the amount of 3 percent, or $10. If your credit card charges you 20 percent interest each month, part of that payment goes toward your interest and part of it to your principal, which is the amount you originally borrowed (so in this case, your principal amount would be $2,000 overall).
If you pay the absolute minimum amount your first month, you will end up paying $33.33 in interest. This is your principal amount multiplied by your interest percentage requirement, divided by 12 to get the cost of one month, or 2000 x 20% / 12.
In full, your first month you would pay $60, which is 3 percent of your remaining balance. Your remaining balance, after subtracting your principal payment of $26.67, is $1,973.33.
If you continued to pay off your debt at the same rate, over the next 15 years you would end up paying a total of $4,240, which comes out to $2,240 in interest alone. That means you would pay more in interest than the original principal amount.
However, if you instead paid $10 above your minimum monthly payment, you would only have to pay $3,276 over seven years.
It all depends on how much was charged to your credit card, how much you are required to pay in interest each month and how much money you decide to pay monthly. You can also watch the video if an audio and visual representation of the information covered above will help you to better understand the basic concept of how credit card interest works and how to calculate how much you might owe.
Here’s how to stay out of debt forever
It’s simple, really. There are two things you can do: you can either use your credit card as infrequently as possible, or pay back your credit card debt as quickly as you can.
To remain financially healthy, it’s a good idea not to borrow too much money, especially too much at one time. It might seem fine now, but if you aren’t careful, you might end up losing a lot of money down the road, money you might really need. If you do have to borrow money, try to borrow in small amounts you will be able to pay back the next time you get your paycheck.
Avoiding credit card debt is possible, but so is calculating interest if need be. Always be mindful of your spending. Create a budget and don’t hesitate to allow yourself some extra money for spending each month. Never borrow money you aren’t certain you will be able to pay back. Emergency situations are the exception of course, but creating a budget with an emergency fund can help as well.
Be smart with your money. There are ways to earn and spend that don’t leave you biting your nails as the end of the month draws near. These calculations are simpler than you think, once you understand all the components.