When you compare credit card offers, APR is the most important feature to determine the best deal. It is the main factor that defines the cost of your borrowing. However, interest rate does not show how much you actually will pay - there is a difference between the interest rate and the interest charge. The interest charge is the actual amount of money that you need to pay for interest. It is based on your APR. For example, if you credit card balance is $1000 and your APR is 15%, and then your total interest charge for the year is $150.

However, it doesn't mean that you will pay $150 divided by 12 months. The balance constantly changes - one month you can pay off your debt in full, another month you can spend more than $1000 for a large purchase. So how do the credit card companies calculate your interest charge when the balance is changing? There are three main methods to figure out how much interest you need to pay. Read attentively the terms and conditions of your credit card agreement to find out which method is used by your credit card company. Generally, the methods are the following:

Average Daily Balance

Average daily balance is the most widespread method of calculating your payment due. It produces an interest rate nearly equal to the expected rate.

In order to calculate average daily balance, the credit card issuer divides the sum of daily outstanding balances by the number of days in the billing cycle (usually 30 days). For example, your credit card balance is $200 for the first 20 days of the month, and you spend $300 on the 21rd day. Then your average daily balance is (200 x 20) + (300 x 10) divided by 30 - an average daily balance of $233.

Then this amount is multiplied by a card's monthly periodic rate, which is calculated by dividing your high or low APR by 12 months. A card with15% APR would have a monthly periodic rate of 1.25 %. So your interest charge is $233 divided by 100% and multiplied by 1.25% - an interest charge of $2.91.

Paying interest on your average daily balance is the same as if you paid interest charge at the end of each day, except that the charges are summarized.

Adjusted Balance

Your interest charge is calculated at the end of the month once all the transactions have been posted. The credit card issuer adds any charges for the month and subtracts any payments. For example, if your balance is $500, and during the month you spend 200$ and make a payment of $100, then your adjusted balance is 500+200-100=$600.

The adjusted balance multiplied by the monthly interest rate is your interest charge for the month.

Previous Balance

The reverse happens: the balance at the start of the previous billing cycle is multiplied by the monthly interest rate. If your balance at the beginning of the month is $500, and you repay $200 during the month, you will be charged interest on $500 this month. Next month, however, you will pay interest on $300, even if you spend more money on your credit card during the month.

When you understand how credit card issuer calculates your interest charge, you know what sum to expect receiving your credit bill. It will help you to plan your spending and save interest.