How Credit Cards Charge Interest! (The Basics)

When it comes to credit card interest, it's really not that complicated to understand how it works, but when it comes to the credit card companies themselves explaining how it works, they don't do a very good job of this because I feel like they want us to stay confused. So I'm just gonna break down credit card interest in this video so that you guys can understand how it works. So I'll be going over the easiest way possible to figure out how much interest you're gonna be paying on your credit card so that generally you can know how much to expect to pay, and I'll also teach you how to not pay interest on your credit cards, which is a very easy approach. Now, before I get into all the interest stuff, I first need to go over a few terms that you've probably heard of when it comes to your credit cards. The first one we're gonna need to talk about is the billing cycle, and then the statement balance, and then the due date, and then once we get these understood, then we'll go right into the interest. Now, the first term that I need to go over for you guys is called the billing cycle, and the easiest way that I can describe it is it's just the invoice period that the credit card uses which is usually a month long to charge you for the previous month. So basically, if you have a 30-day month, then you get charged for 30 days of those purchases, and then you have to pay it back in the following month, and that's the way that the billing cycle works is it's just a month-to-month billing cycle. So if your billing cycle starts on the 15th of the month and it happens to be a 31-day month, then the cycle is going to end on the 16th of the following month. Now, this can get kind of confusing because whenever you open up a credit card and you start using it, that's when your billing cycle starts, so it's not always gonna start on the first of the month. Now, something I do personally, I always call up the credit card company as soon as I get a new credit card, and I make sure that the billing cycle starts on the first, that way it always ends on the last day of the month, so it's very simple to understand because if you've got a couple credit cards and they both have different cycles going, it's really hard to determine when those due dates are gonna be because they're always gonna be different from one another. So the easiest and best advice I can give you guys is to call up the credit card company and make sure that your billing cycle starts on the first, that way it always ends at the end of the month. Now, once your billing cycle ends, the credit card company is then gonna take all of those purchases and they're gonna condense them into your statement balance, which is what you actually owe for that billing cycle. Now, the way that it works is they're gonna give you a due date, which is generally gonna be 25 days after the cycle ends. So if your billing cycle ended at the end of the month, then your bill is always gonna be due around the 25th or the 26th of the next month, and that is what the due date is, and that's how that works as well. So if you ended up spending $1,000 during your billing cycle, then the statement balance is gonna come out and you're gonna owe $1,000 on the statement balance, plus if you're accruing any interest or fees, anything like that, that'll also be on the statement, and then it's gonna be due about 25 days later as your due date, and that's how it works. Now, the trick to never paying any interest on your credit cards is very simple, and all you have to do here is just pay off your entire statement balance in full every single month by the due date, and as long as you do that continuously, you will never pay any interest on your credit cards, and it's as simple as that. But the scary thing here is that if you don't pay off that statement balance in full every single month, then you are gonna be accumulating interest. So for example, if you owe $1,000 on your credit card and you pay all the way up to 999 bucks by the due date, that's not paying it off in full. So in this case, you are gonna start accumulating interest not only on the $1, plus any purchases that you make during the grace period. Now, the grace period, I don't wanna confuse you guys here, but this is just the gap between the cycle ending and your due date, so that 25-day period where you can also make purchases, you're gonna be charged interest on those as well if you're not paying off that statement balance in full every single month. And then to make everything worse, if you are paying interest on your credit card because you didn't pay off the statement balance in full, then it generally takes two billing cycles of paying off the statement balance in full in order to get rewarded and not pay interest again from the credit card. So usually it's gonna take two months of doing what you're supposed to in order to stop paying interest. Now, just keep in mind that every credit card out there has different rules. So if you are curious about any of this kind of stuff, just make sure to check your contract or call them specifically, because if you're just taking my advice here, then you could be wrong. So I just want you to be careful here. Now that you know some of the basics of how credit cards work, I'm gonna teach you how the interest is charged in a very general way. And most of the credit cards out there are gonna be using a method called ADB, which stands for average daily balance. Now there's other methods out there that credit cards use, but I wanted to use this one because it's the most general for most of the cards out there. I'm gonna teach you how this works. So the easiest way to understand how the average daily balance works is that the credit card company is just gonna take each day during the cycle, and they're gonna add up your balance for each of those days. And then they're gonna take an average and they're gonna multiply that by the interest rate. And that's what they're gonna charge you is that final interest rate based on your average daily balance. So for an example here, let's say that you have a 30 day billing cycle. Now, all you're gonna do is just add up the balance every single day during that month. So let's just pretend that you add up all those days and you end up with 36,000. Now, all you're gonna do is take 36,000 and divide it by the number of days in the cycle, which in this case would be 30. So 36,000 divided by 30 ends up being 1,200 and 1,200 bucks is your average daily balance for this specific example. So now we know how much the average daily balance is, which is $1,200 in this example, but we wanna know how much interest is being charged. So in this case, let's just pretend that the credit card issuer has a 20% interest rate. All we're gonna do is get that down on a monthly level. So just take 20% and divide it by 12, and that ends up being a 1.6% monthly interest rate because we're just being charged on a monthly cycle. So now we'll just take the $1,200 average daily balance and we'll multiply that by 1.6% interest. And that's gonna end up being about $19 that we're gonna pay in interest for that specific billing cycle. And this is just the basic math and a basic idea of how to do this. Now, this was just very basic math when it comes to the average daily balance method, and it's never gonna be totally accurate. It's just a good way to ballpark about how much interest you're gonna be paying. Now, the reason I say that it's not accurate is because credit card companies always have variable interest rates, meaning they can fluctuate during the month. So for instance, it might be a 20 to a 24% variable interest rate, and they can change that based on a bunch of different factors, and you don't actually know when or how that's gonna happen. So in order to do the math accurately, you've gotta know the exact interest rate. That's never gonna happen with credit cards, but you can just get a general idea. For instance, if it was 20 to 24%, just assume maybe 22%. Do your math, and you'll be close enough. Now, if you do happen to be paying interest on your credit card, I have a little hack that can help you save some money, and the way that you do this is just by getting your average daily balance a little bit lower every single month. Now, the way that you can do this is that you wanna make your payments as often as possible towards the beginning of the cycle, because if you pay off that amount of money towards the beginning rather than the end, then you are gonna be making that average go down a little bit, and that will save you money in interest. So if you do end up with any extra cash, rather than just saving it up and making one payment on your credit card, use that money as soon as possible so that you can take that average, and you can start chiseling it away and getting it lower, and then you'll pay less in interest rather than just saving up and paying once per month.