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Dr. Don Taylor, CFA, Bankrate.com advice columnistHow 2-cycle billing works

Dear Dr. Don,
I've recently noticed that my credit card has converted to a two-cycle average daily balance method of computing finance charges. I recognize the method is described in the Truth in Lending regulations, but try as I might, I can't avoid the conclusion that this method has the effect of virtually doubling the finance charge for anyone who maintains a relatively stable balance.

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It's not as if the issuer is charging on an average daily balance over two cycles. Instead, it is calculating based on the sum of the balances in two periods. That means to me that every month, I'm paying a finance charge a second time on the preceding month's balance. What am I missing? Does that amount to a subterfuge for doubling the effective APR?
-- Indiana Grump

Dear Grump,
The two-cycle average daily balance approach to calculating finance charges on credit cards charges interest for one billing cycle based on the average balance over two billing cycles. It's a way for credit card companies to effectively get rid of the grace period when a cardholder moves from paying off his bill every month to running a balance. If your balance remains fairly stable from month to month, two-cycle billing won't significantly increase your finance charges.

Here's an example where the cardholder's balance is very stable from month to month:

Example:
   June  July  Aug.  Sept.    
Average daily balance:
Two-cycle avg. daily balance:
Daily rate of interest
Days in billing cycle
Finance charges Total
One-cycle billing: Difference
Two-cycle billing:

In contrast, here's an example where the cardholder goes between a zero balance and carrying a balance:

Example:
   June  July  Aug.  Sept.    
Average daily balance:
Two-cycle avg. daily balance:
Daily rate of interest
Days in billing cycle
Finance charges Total
One-cycle billing: Difference
Two-cycle billing:

This is admittedly an extreme example, but it illustrates that a person who sometimes carries a balance is worse off with the two-cycle average daily balance method of computing finance charges than someone who keeps the outstanding balance fairly stable. 

It's common for credit card providers using this method to include new purchases in calculating the average daily balance. If that's the case, it is presented on your cardholder agreement and billing statement as: two-cycle average daily balance (including new purchases).

If you pay off your balance in full each month you'll keep the grace period on new purchases and won't feel strongly one way or another about two-cycle billing until the next time you carry a balance.

To ask a question of Dr. Don, go to the "Ask the Experts" page, and select one of these topics: "financing a home," "saving & investing" or "money."

Bankrate.com's corrections policy -- Posted: Sept. 1, 2006
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