If the amount of money you are required to pay each month as a minimum payment is a mystery, you should read this article. Understanding how your credit card interest and monthly minimum payment is calculated will help you use your credit card more effectively and save money.
Each credit card company actually has its own way to calculate a minimum payment on your account, although they are all required by law to set a minimum payment that will allow you to pay at least some principle. It may take you a while, but if you do not add to your balance, you will eventually pay off your credit card debt completely just by making the minimum payment.
Credit Card Interest Explained
Your credit card interest rate is commonly known as the annual percentage rate, or APR. Your card’s APR is a nominal rate, since the “effective interest rate” that you incur usually ends up a little higher as interest gets factored in.
If you pay your balance in full each month, you will not need to worry about interest charges. Still, you should always understand the interest rate associated with your card and whether it’s fixed or variable.
Variable interest rates are by far the more common of the two. The interest rates change based on changes to the “prime rate“, which is the interest rate banks charge their most creditworthy customers. You can usually find an index of the current prime rate in The Wall Street Journal – though expect the interest rate you are charged to be significantly higher. Luckily, your bank is required by law to notify you before raising your rate.
Periodic Interest Rate
Most credit cards use as an “average daily balance” method to calculate your interest charges. This means that interest is compounded based on the daily balance on your account.
You aren’t charged interest on a yearly basis. Instead, the interest compounds daily (a little interest is added to your unpaid balance every day). You can figure your daily rate by dividing your APR by 365 or 360, depending on the bank.
For example, assume you have an APR of 18% and your card issuer uses a 360 day year. That works out to a periodic interest rate (or daily periodic rate) of 0.05% per day.
Average Daily Balance
Average Daily Balance is another area that can be confusing, as the amount of interest you owe increases every day you do not pay the balance. Because you do get credit for paying off some of the balance early, your bank looks at your average daily balance, which is the average amount of your unpaid balance over the course of the month. And, luckily, you also get a grace period. So, if you pay in full each month before your due date, you will not be charged any finance charges.
As an example, assume you have a $1,000 balance for 10 days accruing interest. On the 11th day of the month, you make a $300 payment. On the 21st day, you pay another $500. This means your average daily balance is $633. This is the amount the credit card issuer uses to calculate your finance charges.
Calculating Finance Charges
Once you know your periodic interest rate and your average daily balance, you can see how the bank charges you interest (often referred to as the “finance charge”).
Just multiply your average daily balance ($633 in the above example) by the periodic interest rate (0.05%), then multiply it by the number of days in the month. If the month has 30 days, this example would mean interest charges of $9.50.
How to Calculate The Minimum Monthly Payment
The minimum monthly payment on a credit card is the smallest amount you need to pay by the due date each month. Your minimum payment may change month to month, as your bank bases it on your unpaid balance at the end of the billing cycle.
Most credit card issuers have a minimum fixed dollar amount that the minimum payment cannot fall below. The minimum is usually the lesser of $25, or your outstanding balance.
The formula for calculating the minimum due varies by card issuer. But the following are the two most common ways your monthly minimum payment is calculated:
- Percentage + Fee. This means your balance is multiplied by a percentage (usually 1% to 3%), then any fees are added (including late fees, if applicable).
- Percentage + Finance Charge. Your balance is multiplied by a percentage and a finance charge is added. On top of that, other fees, such as late fees, are then added.
Of course, you can always just use our Minimum Payment Calculator if you want a fast and easy way to calculate your estimated monthly minimum.
Minimum Payment Requirements by Card Issuer
Here’s a helpful guide to today’s top credit card issuers and their minimum payment calculation policies.
- American Express: American Express has a number of calcuations they use depending on the credit card, although it’s usually 2% of the balance.
- Bank of America: 1% of the balance, along with finance charges and late fees.
- Capital One: The full balance is due if under $15, otherwise 1% of the balance plus finance charges, past due ffees and 1/12 of the membership fee.
- Chase: The greater of the following is due each month: 2% of the balance or 1% plus any interest and fees.
- Citi: All past fees and finance charges are due, plus anything over the credit limit, along with the greater of the following: the new balance is under $20; $20 if the balance is at least $20; 1% of the new balance plus fees and finance charges; or 1.5% of the new balance.
- Discover: 2% of your balance is your minimum due, or a minimum of $15 plus finance charges and fees.
- USAA: The full balance is due if under $15; 1% of the balance, plus finance charges and fees, not to be under $15.
- US Bank: According to US Bank, the minimum payment is calculated using the greater of the following: 1% of the balance, plus finance charges and fees; or a minimum of $10.
- Wells Fargo: If your balance is under $15, the entire balance is due. Otherwise, 1% of the new balance plus finance charges and fees.
As you can see, minimum payment calculations vary amongst all credit card issuers, although all are similar and stick to around 1% of the balance, plus fees and finance charges.
Why It’s Important
Understanding how your minimum due is calculated is a great way to see how to get yourself out of debt because you’ll understand how much of your payment is going to the principle and how long it will really take to pay off your balance using only minimum payments.
Most financial advisers will tell you to pay extra when you can. By just paying the minimum, you may add years to the loan, and hundreds, if not thousands, of dollars in finance charges.
Ultimately, your goal is achieve credit card balances that you can pay in full each month.