Understanding credit card charges
When shopping for a credit card, it's important to investigate how the finance charge is calculated. There are three common methods of calculating finance charges, and all of them are based on the balance carried by the cardholder during a given billing period. The method a company uses to determine the balance figure affects the amount of finance charge you will pay. The three methods of calculating finance charges follow, listed in order of most to least favorable for the cardholder.
1. Adjusted Balance Method. Here, the finance charge is levied against the balance carried over from the previous billing period after any payments or credits have been deducted. Interest is not calculated on additional purchases made during the billing period. This is the least expensive method to the cardholder.
2. Average Daily Balance Method. This method adds the balance carried over from the previous billing period with any purchases made during the current period. Payments and credits are subtracted from the total. The company then charges interest on the average daily balance carried during the period. This is the most common method.
3. Previous Balance Method. The finance charge is levied on the entire carryover balance of the billing and does not take into consideration any payment made until the following month's bills. Finance charges are not assessed on additional purchases made during the current billing period.
2. Average Daily Balance Method. This method adds the balance carried over from the previous billing period with any purchases made during the current period. Payments and credits are subtracted from the total. The company then charges interest on the average daily balance carried during the period. This is the most common method.
3. Previous Balance Method. The finance charge is levied on the entire carryover balance of the billing and does not take into consideration any payment made until the following month's bills. Finance charges are not assessed on additional purchases made during the current billing period.
Under the Truth in Lending Act, all institutions that issue credit cards are required to disclose which method of finance charge calculation is used and what the annual percentage rate (APR) is.
If you purchase a $500 television with a credit card charging 19.8 percent interest and make only the minimum payments*, it will take you more than two and one-half years to pay off the loan, adding $150 in interest charges to the cost of your purchase. The same purchase on a credit card charging 12 percent interest will cost you only $78 extra.
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