The cost of borrowing: How is interested calculated on a loan or credit card?

Understanding how interest is calculated can help you to manage your repayments and potentially save interest on your loan or credit card.

Interest is the amount charged by a financial institution to let you borrow money. Borrowers are charged interest regularly throughout the life of the loan. It is typically charged at an annual rate, or per annum.

How is interest calculated on a loan?

Interest on a loan, such as a car, personal or home loan, is usually calculated based on the daily unpaid balance of your loan. This typically involves multiplying your loan balance by your interest rate and dividing this by the 365 days in a year. This shows your daily interest charge. As interest is usually charged monthly, the daily interest amount is then multiplied by the number of days in the month.

As a hypothetical example, if you had a home loan balance of $400,000 at the current average standard variable rate in Canstar’s database of 3.52% p.a. (based on a borrower with an LVR of 80%, comparison rates vary depending on the product), your monthly interest charge would be:

  • $400,000 x 0.0352/365 = $38.575 daily interest
  • $38.575 x 30 days in June = $1,157.25 interest for June

Keep in mind that your loan may be calculated in a different way depending on who you bank with. You can use Canstar’s mortgage repayment calculator, car loan repayment calculator and personal loan repayment calculator to get an estimate of how much interest you’ll pay over the life of a loan. You can also use Canstar’s extra home loan repayments calculator to see how making extra repayments could save you time and interest on your home loan.

Calculate interest loan
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What factors impact interest on a loan?

The main factors that influence how much interest you will pay on a loan are:

1. Interest rate

A loan’s interest rate can have a big impact on the total amount of interest you pay. For example, according to Canstar’s mortgage calculator, on a $400,000 loan with an interest rate of 3.52% p.a., monthly principal and interest repayments and a loan term of 25 years, the total interest payable will be $202,036. In comparison, if the interest rate was lower – say 2.19% p.a. as another hypothetical example – the total interest payable would be significantly less at $119,798.

Some of the factors that can determine the interest rate a borrower would pay on a loan include:

  • Their credit history and credit score
  • Whether the loan is fixed or variable
  • For home loans, what the loan-to-value ratio (in other words, how much of a deposit the borrower has)
  • The loan purpose – for example whether it’s for a home to live in or an investment property
  • For personal loans, whether the loan is secured or unsecured

You can compare a range of home loan, car loan and personal loan products using Canstar’s comparison tables. You can sort these tables by interest rate and comparison rate to see what different lenders are offering.

Remember, a loan’s interest rate is different to its comparison rate. A comparison rate combines the loan’s interest rate plus most fees and charges. It is designed to give borrowers a closer estimate of the total cost of a loan per year.

2. Loan amount

The more money you borrow, the more interest you will generally pay. This is because interest is calculated as a percentage of your loan balance. Taking the hypothetical example above, if you were able to take out a $300,000 loan at a 3.52% p.a. interest rate rather than a $400,000 loan, you would pay $151,527 interest over the life of the loan (a difference of $50,509 in interest). On the flipside, some loans are only available to people borrowing over a certain amount and in some cases these loans could offer a lower interest rate than a loan that’s available for small amounts.

3. Loan term

Likewise, the longer your loan term, the more interest you will ultimately pay. For example, if you paid off the hypothetical $400,000 loan above at a 3.52% p.a. interest rate over 30 years rather than 25 years, you’d pay a total of $248,233 in interest — which is an additional $46,197 in interest.

How to calculate interest
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4. Repayment frequency

How often you make repayments can also impact the interest payable. This is because interest is usually calculated on a daily basis. Therefore, if you make more regular repayments (for example, weekly or fortnightly instead of monthly), you will be paying more of the principal amount more frequently and the balance that your interest is calculated on will be lower.

5. Number of days in the month

The number of days in the month can impact your repayment amount. Interest is usually calculated daily, so your interest repayments will typically be slightly higher for a 31-day month compared to a 30-day month.

Other factors, such as whether you make additional repayments or whether you use a mortgage offset account, can also impact the amount of interest payable. Additionally, if you make interest-only repayments for a period of time, this will also generally increase your interest in the long run. This is because you won’t be paying down the principal amount during this time.

By budgeting and managing your finances carefully, you may be able to cut expenses from elsewhere and use the money saved to reduce your loan amount (if your loan allows you to make extra repayments), which would reduce the amount of interest you pay. Canstar’s Budget Planner Calculator may assist you to plan for your expenses generally. Depending on your personal circumstances and the type of loan you are looking for, you may also like to view Canstar’s award winners for our:

How is interest calculated on a credit card?

Credit card interest is usually calculated daily based on the outstanding balance on the card. The balance can include any purchases (where no interest-free period applies), cash advances (such as ATM withdrawals), balance transfers, interest from previous months and other fees and charges. Banks generally charge different interest rates for purchases, cash advances and balance transfers.

When is interest charged on a credit card?

Credit cards typically come with an interest-free period (for example, up to 55 days). This means you won’t pay interest if you pay back your closing balance in full within this period. If you don’t pay your closing balance in full by the due date, interest will start to accumulate and will be added to your card balance until it’s paid off.

Some types of transactions do not come with an interest-free period. For example, cash advances and balance transfers typically do not, although some cards offer a temporary 0% balance transfer period. Where no interest-free period applies, you are charged interest from the date of these transactions until they are repaid.

calculate interest credit card
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Credit card interest example

Interest is charged at the end of the statement period which is usually monthly. As a hypothetical example, if you had a $1,000 outstanding purchase balance on a credit card with a 13% p.a. purchase rate, your daily interest charge would be:

  • $1,000 x 0.13/365 =  $0.356 daily interest

If you did not pay your outstanding balance during the statement period, an example of your monthly interest charge would be:

  • $0.356 x 30 days in June = $10.68 interest for month of June

What factors impact credit card interest?

Some of the factors that can impact the amount of credit card interest you pay each month include:

  • Whether you repay your closing balance in full or make the minimum monthly repayment. If you only pay the minimum amount, you won’t get the benefit of any interest-free period and you may end up paying a lot in interest over time.
  • Your outstanding balance.
  • Your credit card interest rate (for example, cards that allow customers to earn rewards points may come with a higher interest rate than cards with a more basic offering).
  • The number of days in the month (if interest is calculated on a daily basis).

You can avoid paying interest on your purchase balance by paying your closing balance in full by the due date. If you are looking to reduce the amount of interest you are charged on any outstanding balance, you may want to consider switching to a low rate card. Canstar has rounded up some of the credit cards in our database with interest rates below 9%. If you are finding it difficult to manage your credit card repayments, you may want to contact a financial counsellor for help. Financial counsellors offer free, independent and confidential advice.

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