Most people know that credit cards have high interest rates, often between 20% and 30%. But few understand exactly how that interest is calculated and why it grows so aggressively. Unlike a mortgage, which typically uses simple interest calculated monthly, credit cards use daily compounding interest.
The Daily Periodic Rate (DPR)
Lenders take your annual percentage rate (APR) and divide it by 365 days to get your Daily Periodic Rate. If your APR is 24%, your DPR is roughly 0.065%. Every single day, the bank multiplies your average daily balance by this rate and adds that interest to your balance. The next day, they calculate interest on that new, slightly higher balance. This is 'interest on interest'.
The Minimum Payment Trap
Credit card minimum payments are usually calculated as 1% to 2% of your balance plus interest. This is designed to keep you in debt for as long as possible. If you only pay the minimum, you are barely covering the interest that compounded during the month, meaning your principal balance remains almost untouched for years. On a $5,000 balance at 24% APR, it could take over 20 years to pay off if you only make minimum payments, and you would end up paying over $10,000 in interest alone.
How to Win
The only way to win the credit card game is to pay your balance in full every month. If you are already in debt, stop using the card immediately. Every new purchase starts accruing interest the moment it's charged if you aren't in a grace period. Use a personal loan or a 0% balance transfer card to 'reset' the math in your favor.