Still not sure how your credit card payments work? Knowing the specifics can help you make smart decisions and manage your debt: how the payment is calculated and how each payment goes towards reducing your debt (or not).
Online credit card calculators offer some helpful numbers, but they don't help you understand how the numbers work. Maybe you are considering putting a big purchase on your credit card, or you are strategizing a debt payout plan. Either way, you will be a wise consumer if you go behind the numbers.
Fortunately, the process of calculating your payments (and costs) by hand is not that difficult. If you can remember how to do it multiple times or a calculator you get everything you need.
The minimum payment
Start by finding out the minimum payment that is required by your credit card company. This is generally calculated based on your balance.
Example: Your card issuer requires you to pay 3% of the outstanding loan amount. You owe $ 7000 on your credit card. The minimum payment is 3% of $ 7,000, which is $ 210. To find this answer, multiply $ 7,000 by .03 (which is the same as 3% - learn more about converting percentages and decimals).
Your minimum payment is determined by your card issuer so that you will need to look up the requirements specific to your account. Would you like to learn more? See how to find your minimum payment and common methods of calculation.
First, the interest
If you make a payment, 100% of that money will not go to your debt. In other words, the balance does not go down from $ 100 when you make a $ 100 payment (provided you have a 0% interest deal). Instead, the card company will initially take their cut of interest.
To find out how much is going towards interest, you'll do another calculation (don't worry, it's pretty easy - but there are a few steps involved):
- Find the interest rate you pay on your card (12% April, for example)
- Convert the annual rate to a monthly rate of 12 by division (because it's 12 months a year - so you'd pay 1% a month)
- Multiply the monthly rate of your credit (1% by 7,000)
- The answer is how much you're spending on interest ($ 70 in this example)
The steps above provide a simplified monthly interest calculation. However, your card issuer could charge interest daily. If so, the calculation is more work, but follows a similar procedure:
- In step 2 at a daily rate from the annual rate of 365 parts (it's 0.0329%)
- Calculate the daily interest charge ($ 2.30 in this case)
- Add this fee to your account balance, for a new total of $ 7,002.30 after the first day
- Repeat the process for every day of the month
Then the head
After you pay interest, the rest of the payment goes to your debt (also known as the "principal" part of your loan). How to find subtract interest from your total payment to find out how much capital you are paying out in a month.
In our example, your payment is $ 210 and interest costs are $ 70. Subtract: 210-70 = 140, so you will be paying out $ 140 of your loan this month. That brings your credit balance to $ 6,860 for the next month.
As you may have guessed, you will need this number to calculate the next month's payment. If you all do this by hand, the process is time consuming, but there are ways to speed up the process.
Keep in mind that if you pay more than the minimum payment, which is always a smart move, you will pay off your loan balance faster. The amount that goes into interest this month is fixed - there is nothing you can do at this point. But you can speed up your debt repayment and spend less on interest in the next month by paying more than the minimum.
Many months, many calculations
You have seen how to calculate payment and interest for a single month (and start on the next month), but how can you calculate a longer period over?
To see the whole process of paying off your debts, it's easiest to use a table or a hand-made table (unless you use an online calculator - which you won't allow to adjust that much). The idea is basically the same as having a home or car loan repayment schedule: each line represents a payment.
It can take a small amount of wizardry spreadsheets, but it's not the most difficult task and you'll have a valuable skill. With each new line, looks back on the loan balance at the end of the previous month (in the line above). For a sample of how your spreadsheet might look like, skip until the last image of this tutorial.
Variations on the subject
By now you have a basic understanding of how most credit card payments work. But every card issuer is different, and your card may work slightly differently. With what you've already learned, you should be able to find out how to calculate your own payout with almost any card issuer.
- If your card has an annual fee, just add that fee to your loan balance when the fee is charged
- If your interest rate will change in the future, one shouldn't forget how to run the numbers and make the calculation
- If you decide to skip a payment (which you probably shouldn't be doing) for the holidays, make that payment a zero this month