University of Illinois Extension

Choose the Best Credit Card Interest Rate

The interest rate on credit card purchases and balances can be much higher, depending upon how the finance charges are calculated. The factors that influence the interest rate and finance charges include if you paid last month's balance or have new purchases.

Most card issuers use the Average Daily Balance Method, which include or exclude newly billed purchases, to calculate your finance charges. To compute the balance due, the card issuer first totals the beginning balance for each day in the billing period. Next, any payments credited to the account are deducted on the day received. New purchases may or may not be added to the balance, depending on the plan, but cash advances are added. The daily balances are summed for the billing cycle, and the total is then divided by the number of days in the billing period. The result is the "average daily balance." New purchases increase your finance charges. And, if you carry a balance from last month, you don't have a grace period on anything that month. You're charged interest from the first day you buy an item.

The Adjusted Balance Method takes into account payments you've made but not new purchases. New purchases are not included in this method. With this method, you'll often pay the lowest finance charges.

Under the Previous Balance Method, your finance charges depend on last month's balance. Payments and purchases you make this month don't affect finance charges. Some creditors also exclude unpaid finance charges in computing this balance. This method can be costly.

The chart on this page compares different methods used to calculate finance charges. In the example below, the APR is 18% a year, or 1.5% a month. Using the various methods, the average monthly finance charge could be as little as $1.50 to as much as $6.00. The calculations use a $400 balance.

Ways Interest Costs are Figured

  Average Daily Balance (excluding new purchases) Average Daily Balance (including new purchases) Adjusted Balance Previous Balance
Monthly Rate 1.5% 1.5% 1.5% 1.5 %
APR 18% 18% 18% 18%
Previous Balance $400 $400 $400 $400
New Purchases $50 on the 18th day $50 on the 18th day -- --
Payments $300 on 15th day
(new balance - $100)
$300 on 15th day
(new balance - $100)
$300 $300
Average Daily Balance

$270* $250** N/A N/A
Finance Charges $4.05 (1.5% of $270) $3.75 (1.5% of $250) $1.50 (1.5% of $100) $6.00 (1.5% of $400)

*To figure average daily balance (including new purchases):
($400 x 15 days) + ($100 x 3 days) + ($150 x 12 days) divided by 30 days = $270

**To figure average daily balance (excluding new purchases):
$400 x 15 days) + ($100 x 15 days) divided by 30 days = $250

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