Line of credit interest is calculated using the daily balance method: the lender applies a daily rate to each day’s outstanding balance and adds up the charges for your statement period. Paying early reduces the balance sooner, so you pay less interest.
How line of credit interest is calculated in Canada usually comes down to the daily balance method: the lender applies a daily interest rate to the balance you owe each day, then adds up those daily charges for your statement period. That is why paying early—even a few days before the due date—reduces the balance that interest is calculated on and lowers your total cost.
| Stage | What happens | Why it matters |
|---|---|---|
| 1. Annual rate to daily rate | The lender converts your annual interest rate into a daily rate, often by dividing by 365 (or 366 in a leap year). | A smaller rate is applied to each day's balance. |
| 2. Daily balance | For every day of the billing cycle, the lender looks at the principal you owe that day. | Payments and new charges change the balance from the day they post. |
| 3. Daily interest | Daily interest = daily balance × daily rate. | Higher balances or more days at a high balance mean more interest. |
| 4. Total for the period | The lender adds up all the daily interest charges for the cycle. | This total is usually posted to your account monthly. |
| 5. Compounding | If the posted interest is not paid, it may be added to principal. | Future interest can be charged on unpaid interest. |
| 6. Payment timing | A payment reduces the balance on the day it is credited. | Paying earlier means fewer days of interest on the amount you paid. |
How the daily rate and daily balance work together
The daily balance method starts with your annual interest rate. Lenders convert that annual rate into a daily rate. In Canada, many agreements use a 365-day divisor, but some may use 366 in a leap year or the actual number of days in the year. Your specific agreement controls the calculation, so check the disclosure documents you received when the line of credit was opened. The basic formula is: daily interest = outstanding principal × annual rate ÷ number of days in the year. The lender then repeats that calculation for every day in the billing cycle.
If your balance changes because of a purchase, a cash advance, a payment, or a fee, the next day's calculation uses the new balance. This is different from a simple monthly interest calculation that uses one balance for the whole month. Because the balance is measured daily, the timing of transactions and payments matters. A payment that posts on the 5th reduces interest for the rest of the month; the same payment on the 25th does not. The Financial Consumer Agency of Canada explains that credit agreements must disclose key cost information, including interest and how it is calculated. You can read more on the Financial Consumer Agency of Canada loans page. If you have a co-signer, they also have disclosure rights under FCAC’s joint borrower disclosure page.
A worked example using the daily balance method
To see why paying early matters, use variables instead of a specific lender's rate. Suppose your annual rate is r (expressed as a decimal) and the lender uses 365 days. Your daily rate is r ÷ 365. Imagine you carry a $5,000 balance for the first 10 days of a 30-day cycle. On day 10, you pay $1,000, leaving $4,000 for the final 20 days.
Interest for the first 10 days: $5,000 × (r ÷ 365) × 10. Interest for the last 20 days: $4,000 × (r ÷ 365) × 20. Total interest = ($50,000 + $80,000) × r ÷ 365 = $130,000 × r ÷ 365. If you had not made the payment, the interest for 30 days at $5,000 would be $150,000 × r ÷ 365. The difference is $20,000 × r ÷ 365. That difference is exactly the interest on $1,000 for 20 days. In other words, paying $1,000 ten days early saves you 20 days of interest on that $1,000. If you pay on the last day, you save almost nothing.
This example shows that the amount you pay and the date you pay both matter. A larger payment reduces the daily balance more. An earlier payment reduces it for more days. If r is higher, the savings are larger. You can test different payment amounts with a loan payment calculator. If you are co-signing for someone, remember that the same daily balance method applies to the debt you may have to repay; see what a co-signer is for the basics.
Why paying early matters more than you might think
Many borrowers focus on the annual rate, but the daily balance method means the date of payment is almost as important as the rate. If you pay on the due date, the lender has already charged interest on the full balance for the entire cycle. If you pay two weeks early, the balance drops two weeks earlier, and interest is calculated on the lower balance for those 14 days. Over a year, small timing changes can add up, especially if you carry a balance most months.
Line of credit interest often has no grace period like a credit card might. Interest typically starts from the day a transaction posts. So if you use the line of credit for a purchase, the sooner you repay it, the less interest you pay. Some lenders calculate interest from the transaction date, not the statement date. This is another reason to make payments as soon as you have funds. The Bank of Canada publishes interest rate data that can help you understand how prime rate changes may affect variable-rate lines of credit, but your lender's rate is set by your agreement. You can review the Bank of Canada’s interest rate data for context.
Variable rates, prime, and changes during the month
Many lines of credit in Canada have variable rates tied to the lender's prime rate. If prime changes during a billing cycle, the daily rate can change too. The lender may apply the old rate for days before the change and the new rate after. That makes the calculation more detailed, but the principle is the same: each day's balance is multiplied by that day's daily rate. Fixed-rate lines of credit do not change with prime, but they still use a daily balance method. The difference is that the daily rate stays constant.
When comparing offers, ask whether the rate is fixed or variable, what the spread is over prime, and how often interest is compounded. The federal Criminal Code sets a criminal interest rate ceiling of 35% per annum, and lenders must comply with that rule. You can read the legal text at Criminal Code section 347. That ceiling does not tell you what a fair rate is, but it is a legal limit. Rates vary by lender and province, so read your agreement and disclosure documents carefully.
How payments are applied and when interest compounds
When you make a payment, the lender may apply it first to interest and fees, then to principal. That means if you only pay the minimum, you might not reduce principal much, and the next month's interest is calculated on almost the same balance. If interest is not paid, it can be added to the principal balance. That is compounding, and it means you then pay interest on interest. To avoid compounding, try to pay at least the interest that has accrued plus some principal.
Check your statement or online account to see how your payment was applied. Some lines of credit require interest-only payments; others require a percentage of the balance. The FCAC's loans page explains that your credit agreement must tell you how payments are applied and how interest is calculated. If you are a co-signer, you should understand that you are responsible for the debt if the primary borrower does not pay, including any accrued interest. If you have damaged credit and are considering a co-signer, review the costs carefully; see bad-credit loans for more context.
Common mistakes
- Waiting until the due date to pay. You lose the benefit of reducing the daily balance earlier.
- Assuming interest is calculated monthly on a single balance. Most lines of credit use daily balances.
- Making a payment on a weekend or holiday without checking when it will be credited. A payment that posts on the next business day still leaves the old balance in place for those days.
- Paying only the minimum. If the minimum does not cover the interest, the balance can grow.
- Ignoring the difference between the transaction date and the statement date. Interest may start earlier than you think.
- Not reading the agreement for the daily divisor (365 or 366) or compounding frequency.
- Forgetting that variable rates can change mid-cycle.
- Co-signing without understanding that you may have to pay interest that accrues.