If you only make a partial credit card payment, how does the interest add up?

It's a question I get asked fairly often. Although my permanently standing advice will always be to always pay off your credit card balance on-time and in-full, I realize that sometimes that's not realistic. If you've found yourself in a situation where making that full payment will keep you from eating anything but ramen noodles for the next three months (though, I may go to that extreme, personally, I don't want you to have to suffer) then it's time to make a plan and understand what the consequences will be.

Why will I no longer harp you for not making that in-full payment? Well, because life is also meant to be enjoyed, and this blog is about more than just financial freedom, there's life freedom that we have to consider as well, and ramen noodles doesn't exactly scream “my life is mega glam” when it's paired with sitting cross-legged on your floor watching old episodes of Scandal on Netflix.

Alright, let's break down that stinking credit card statement.

What You Owe:

First of all, let's look at what is actually due. There are a lot of “balances” that show up on the statement, so it's important to know what you actually owe.

For the most part, you want to pay attention to the item listed as “New Balance”. This is the balance of your last credit card statement, generally due the following month.

You often have the option of paying this “New Balance” the “Current Balance” or the “Minimum Payment”.

If you want to avoid interest, pay the “New Balance” on-time and in-full.

If you don't have all the funds, but want to avoid a late fee and a higher interest rate, pay the “Minimum Payment” on-time and in-full (this will be significantly less than the “New Balance” amount, but you will end up paying a lot more for your purchases in the form of interest.

If you want to keep your utilization as low as possible for your credit score or you just hate seeing any sort of balance on your credit scores, you can pay the “Current Balance” if you're feeling frisky. This is your “New Balance” (the total amount of transactions you've made up until the balance statement closed) plus the total of any additional transactions you've made up to today. (sometimes including pending transactions as well).

How Interest Works:

Alright, so you know your options for payment, but you can't quite afford to pay the full balance from your last statement (things got a little crazy last month and well, ish hit the fan).

So, you pay as much as you can. You definitely hit the minimum payment (because it always seems to be only $25) and you put a couple extra hundred toward the bill, but you still have some money leftover… how much will your interest be?

Perhaps you're wondering if you will be charged interest on the remaining amount from the statement or on the entire current balance on the card?

Here's what to know about interest:

  • Interest is accumulated based on the statement balance or “new balance” not the “current balance.”
  • Interest is also accumulated on a daily basis (your APR/365), called the periodic rate or daily periodic rate.
  • The daily periodic rate calculates interest based on an average daily balance. So if you make payments throughout the month, your average daily balance will be smaller as you chip away at the payment that was due prior to interest being added.
  • The sooner you make payments, the lower your average daily balance and the lower your interest due will be.

An Example:

Your balance due is $1,000 from your most recent statement balance, but you can only pay $700 by the actual due date.

The remaining $300 will accumulate interest at your APR divided by a number between 360-365 (whatever your bank chooses) for every day that goes by until you can pay off the full amount you owe. This amount may seem small but will add up over time… and who likes paying more for something they already own?

If your card has a 20% interest rate, your daily rate is 20%/365 = 0.00054795.

If you don't pay off the $300 all month, the interest at the end of the month is $300*0.00055*30 days = $4.93.

This amount is now added to your new balance for the following month, and interest will start growing from that number plus all the transactions you made throughout the 30 days, assuming you don't make any payments toward your card.

If you make payments throughout the month toward that remaining $300 from the month, you can dwindle down the amount of interest you will owe since it accumulates daily.

To understand more about how this works, I recommend checking out this piece by Nerd Wallet that walks you through more advanced techniques like the average daily balance and how interest accumulates when you make multiple payments throughout the month.

Your turn: Did this make sense? What part of this confuses you or what did you learn? Any questions please leave below or send me an email.