How Are Credit Card Finance Charges Calculated?
Finance charges assessed to credit cards can be very costly to consumers, and therefore, it is important to understand how credit card companies calculate the finance charge that appears on a monthly bill. Unfortunately, there is no easy answer. While all credit card companies tend to calculate the rate of interest in the same manner, the balance that they use to calculate the finance charge varies from company to company.
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Periodic Rate
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No matter what way the credit card company determines the balance used to assess the finance charge, the periodic rate is always employed. To calculate the periodic rate, the annual percentage rate or APR is divided by the number of periods in a year, which is typically 12.
Example: 12%APR / 12 months or periods in a year = 1% periodic rate
Ending Balance
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In this method, the periodic rate is multiplied by whatever the balance of the card was whenever the billing cycle ended and the statement was printed.
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Previous Balance
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Some credit card companies use the account balance from the first day of the billing cycle. With this method, the purchases for a given billing cycle are not included in the calculation.
Average Daily Balance
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For this method, the total balance, including payments and purchases for each day of the billing cycle, is divided by the number of days in the period to determine the balance used for the interest calculation.
Two-Cycle Average Daily Balance
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In this method, the same formula is used as with average daily balance, except the balances and number of days from two billing cycles are used as opposed to one.
Adjusted Balance
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Adjusted balance is the most borrower-friendly form of calculation, as it results in the lowest finance charge. With this method, any payments made during the billing cycle are subtracted from the balance at the beginning of the billing cycle to obtain the figure. Purchases made during the billing cycle are not calculated into the balance at all.
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