If you're like most of us, you've probably received at least one credit card bill with the new format required by the CARD Act that went into effect on February 22. The new format explains how long it will take to pay off your card if you pay only the minimum required.
Personally, I like this new format. It clearly spells out what paying just the minimum costs you, not only in the time it'll take for you to pay off that balance, but also in the total amount of interest you'll owe while you're paying down your debt.
If you pull out any of your recent credit card bills, you'll see the new chart, which will show similar payoff information for your own card. I recently looked at a sample bill for a card with a balance of $11,000 that requires a $178 minimum payment each month. The new chart indicates it will take 25 years to pay off that bill in full when you pay only the minimum. And the total you'll end up paying, including interest? $17,054. And that's for a card with a low 6.99% interest rate! Most people have interest rates three or more times that rate. The chart for this sample bill also showed that if you double the minimum payment, which in this case would be $341, you could pay the card off in three years and save nearly $5,000 in interest, for a grand total of $12,306.
Have you looked at this new box on your credit card bills yet? If you're in the habit of just paying the minimum and not taking the time to read the bill, change that bad habit now! Get to know that new box -- it can help you save lots of money in interest expenses. Pay down the most you can on the highest interest cards, and you'll see those numbers quickly drop.
But just how is credit card interest calculated anyway?
If you pay your balance in full each month, you shouldn't have any interest charges no matter what your annual percentage rate (APR) is. If you're not in the habit of paying off your cards every month, however, then you need to know the interest rates on each card and understand how they affect just how much you owe.
You should find a statement on the bill that indicates the card's annual percentage rate, which for most people today ranges between 14.99% and 29.99%. You should also check to see if that's a fixed or variable rate. Most cards today charge variable rates, which means when the Federal Reserve starts raising the prime rate, your credit card rate will go up as well.
Next, see how your credit card company calculates interest charges. You'll find most of them use an average daily balance method. That means that interest accrues daily.
Then you'll have to figure out your average daily balance. You can determine this number by adding up the balance each day of the month and then dividing that figure by the number of days in the period, which is most likely a 30-day period. Most credit card companies attempt to make this easier for you by giving you an average daily balance as part of your rate summary.
Next, you'll need to calculate your periodic interest rate. You can do this by dividing your annual interest rate by 365 to get what's called your "periodic rate." You'll find this rate in your statement's rate summary as well. To get your interest due, you multiply the average daily rate by the periodic rate. Then multiply this number by the number of days in the month, and that will be your interest charges for the month.
If you do all these calculations and find an error, call your credit card company to ask them why your numbers are different. You may find that they're calculating interest in a different way.
If you've always been a "minimum payment" kind of person but want to pay off your cards sooner, BankRate.com offers an excellent credit card calculator that allows you to try various payoff scenarios. You can create a payment schedule based on the minimum payment or a fixed payment of your choosing. Their tool can help you create a payback plan that saves you money by helping to pay down your debts faster.
Lita Epstein has written more than 25 books including The Complete Idiot's Guide to Improving Your Credit Score and The Complete Idiot's Guide to Personal Bankruptcy.
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