Where do finance charges come from?
you pay the finance charge on your bill, but do you understand how the credit
card company arrives at the number?
Check out four of the most common calculation methods. But be
warned: the method alone only tells part of the story. To make sure you're getting
the best deal on a card, ask how the company calculates the charges and whether
interest is calculated on a daily or monthly basis. Find out if there is a grace
period for new purchases. And have the company rep explain when and how your
monthly payments are applied.
Here are the calculation methods you're most likely to see:
Average daily balance: The company
averages your daily balance. For instance, if you charged $100 on the first
day of June and charged an additional $200 on the 16th, your average daily balance
would be $200. That number times roughly one-twelfth your annual percentage
rate (APR) equals your monthly finance charge. Interest may be calculated on
a daily or monthly basis.
The company calculates the actual balance you carried each day of your billing
cycle and multiplies it by roughly 1/365th of your APR and adds it together.
Two-cycle balance: Similar to an
average daily balance except that the daily average is based on your last two
billing months, not just one. With this method, if you don't pay off your card
in full one month, you'll be hit with retroactive interest on your next bill.
Previous balance: The bill will
show beginning balance and ending balance for your account. The finance charge
is based on the outstanding balance at the beginning of the billing cycle.
Source: The Federal Reserve
-- Posted: Jan. 9, 2003