WHAT IS A FINANCE CHARGE
If you have a credit card and know how it feels to pay for something, chances are that you understand a little about finance charge. As a fact, the finance charge enables you to make a profit when you lend your money. It is also the total dollar amount paid to borrow which includes interest you pay and fees for getting a loan.
The finance charge is usually expressed as an annual percentage rate (APR) of the amount you owe. It will allow you to compare the costs and advantages of different loans.
With your credit cards, you can buy things and pay for them at a future date. Let’s say it takes you months or years to payout the balance. You’ll need to pay a fee in the form of finance charge which increases the cost you pay for owning a credit card. Of course, you can’t avoid this, but you have to be smart about the timing and amount of the credit card payments.
Finance charges serve as compensation for the lender who provided the funds or extends credit to the borrower. It’s not uncommon for finance charges to vary from lender to lender or from product to product. Why? Fees like interest payments, one-time fees can amortize on a daily or monthly basis. It means you can spread payments can over a period of time.
Assessing Finance Charges
Further, you can assess finance charges based on the past due to average daily balance. The balance on the invoice need not be considered at the time of the assessment. Here, the average daily balance is determined through the past due to invoices in a specified period. The finance charges are assessed based on periodic rates.
A start date and an end date are required to calculate the past due balances for the specified time.
A charge for the invoice will be assessed if the invoice is past due during any of the time finance charges are being assessed.
Sometimes the specific invoices that are past due at the time of finance charge assessment are considered. That means, if an invoice was 30 days past due and paid for the day before assessing finance charges, one can’t assess the finance charges on the paid invoice.
The finance charge is always listed in several places on your monthly credit card billing statement. It usually reads an account summary with balance, payments, credits, purchases and interest charge. Accompanying this statement is a breakdown of your finance charges by types of balances you’re carrying.
Calculating your finance charge
The statements of your credit card bill will contain your finance charge, so you don’t need to calculate the value. But, it won’t be a bad idea if you learn how to calculate it.
Calculating it can help you verify that your bank billed your finance charge correctly. Also, calculating it shows you the finance charge to expect.
You only need to know 3 numbers to calculate your finance charges:
- The APR
- The credit card (or loan) balance
- The billing cycle’s length
Here’s how to calculate your finance charge in an easy way
Monthly rate X Balance
Let’s say every billing cycle lasts for one month and you have a $700 balance in your credit card with a 20% APR.
You need to determine the periodic rate. To do this, divide the APR by the billing cycles in 12 months. Make sure you to change percentages to a decimal.
That said, the periodic rate will be:
0.20 / 12 = 0.0167 or 1.67%
The monthly finance charge is:
0.0167 (monthly rate) X 700 (balance) = $11.69
How to calculate Short billing cycles
The billing cycle of some credit cards is shorter than one month – for instance, 20 or 28 days. If your billing cycle is not up to a month, calculate the finance charge this way:
APR X Balance X days in billing cycle / 365
So if the billing cycle is 28 days long, your finance charge for 28 days will be:
0.2 X 700 X 28 / 365 = $10.739
In this example, you’ll see that the finance charge is lower even though the interest rate and balance are the same. That’s because you’re paying for 25, which is obviously lower than one month.
So these are easy ways to calculate your finance charge. But it might be different from what you see on your billing statement. Your creditor might use 1 of 5 finance charge calculation formulas. Check the rear of your credit card statement to find out the method used by your credit card issuer.
Often, credit card issuers make use of the average daily balance method. It’s just like the daily balance method. With the average daily balance method, every daily balance is averaged first. Afterward, you can calculate the finance charge based on that average.
If you want to calculate it, you must know the balance in your credit card at the end of the day. Sum up the daily balance and then divide it by the number of days in your billing cycle. Next, multiply the result by the days in your billing cycle and the APR. Divide it all by 365.
If you have no interest rate promotion or if you pay the balance earlier than the grace limit, you may not have a finance charge.
Paying off your finance charge
You need to make your least credit card payment, which is often printed on the first page of your credit card billing statement. It covers your finance charge plus a small percentage of the balance. But if you’re only paying the minimum payment, your balance will lessen by only a small amount each month. It’s because most of the payment goes toward paying interest.
It’s common in the case of credit cards, to always pay more than the least balance to reduce the finance charge you owe. Paying the minimum alone before the end of the grace period means you will owe interest and fees on the remaining balance.
The smaller that balance payable is, the less you will owe. It’s the same for mortgage payments and car loans, with some exceptions. When paying the loan, the aim is to knock down the principal, so that the bank has less to charge interest and fees on.
Reducing the finance charge
One simple solution to this statement is to pay off your balance owed faster. Since the finance charges can greatly increase the amount you will have to pay on your credit card, you might want to take a look at these options…
- Always pay attention to the charged rate
When you receive information about rate increases by mail, ensure open and understand them. If you notice a higher rate, contact the card issuer to confirm why the interest rate high. Also, you should ask what can you can do or the issuer to prevent or reduce the hike.
- Read statements carefully
There’s no telling what suspicious charge in the form of interest and fees might creep up. It’s a given that it is more difficult to get the charges removed or reduced once they have been in your account for more than 30 days.
- Pay down your balances
It’s a well-known fact that credit card issuers make use of compounded interest rates. This means that interest will be charged on interest at the end of each billing cycle. If you have any unpaid balance on the card, it rolls over into the next month’s billing cycle.
So, it will be assessed at a higher interest rate. Further, the interest rate is charged against the balance on which you have already accumulated an interest fee in past months.
- Use the credit card
You get goodwill and credit not when you pay your account balance on time, but also in full. A good account history with the card issuer leaves you with an option to ask for credit increase or reduction in interest rates. You can study other card options should a balance transfer be on your mind.
Avoiding finance charges
For some, this is often the hardest part. Don’t carry the balance, that’s all you need to do. To void the charges entirely, pay every balance in full before the due date. From the above, it’s easy to see that paying off the balance before the zero interest rate promotion expires helps you avoid future charges.
Another way includes not using the credit card while paying down the balance. It helps you avoid more interests, charges or fees.
Not all types of balances have windows to help you avoid finance charges though. Grace periods are typically absent from balance transfers and cash advances. In effect, finance charges begin to add up as soon as the balance gets to your card. So if you’re thinking what I’m thinking, you’d do best to avoid such transactions completely – unless you have no interest on your credit card.
To conclude, a good understanding of finance charges helps you handle it better. Also, make sure you get all vital information when choosing a credit card issuer.