Credit cards have so many fees that cardholders may not even be aware of. The most important one to know is finance charges. Many do not know what it is or how it can impact the amount you pay each month, so you may be leaving yourself having to pay more than necessary.
If you would like to find out what finance charges are and how you can reduce it, continue reading this post to learn more.
Finance Charge Definition
A finance charge is the interest fee that is charged on debt you owe from credit accounts. It is directly linked to a card’s annual percentage rate and calculated using the cardholder’s balance.
It is more of a penalty charge for not making you pay your full balance every month. If you carry a balance to the next month, you will have to pay a finance charge.
Interest vs. Finance Charge
Interest is a type of finance charge that occurs when cardholders carry a balance on their credit cards, thus needing to pay more.
On the other hand, finance charges include interest, as well as maintenance fees, late fees, and more. Interest rates can vary from cardholders and card issuers, and finance charges vary accordingly.
How Credit Card Finance Charges Are Calculated
Finance charges vary from month to month and are not predetermined. In order to calculate finance charges, you generally divide your APR by 365. Then, multiply the resulting credit card rate by your outstanding balance. After these steps, it becomes less general and depends on various things.
Your finance charge can be calculated using many different methods. Depending on the company you are banking with, it may be one of these:
- Average daily balance: This is the most common method.
- Takes the average of your balance during the billing cycle.
- Adds each day’s balance together.
- Then, divides by the number of days in the billing cycle.
- Daily Balance
- Uses the credit card balance from each day of your billing cycle.
- Multiplies each day’s balance by the daily rate.
- All of the days are added together to get your charge.
- Ending Balance
- Takes beginning balance
- Subtracts payments plus charges made throughout the billing cycle.
- Previous Balance
- Pulls your balance at the beginning of the cycle (same as the ending balance of the last billing cycle).
- Charges and payments during the billing cycle do not affect the financial charge calculation.
- Adjusted Balance: Typically the least expensive for cardholders.
- Uses the balance you carry at the beginning of the billing cycle.
- Then, subtracts any payments made throughout the month.
Factors That Affect Finance Charges
There are many factors that can affect finance charges. However, the most important one is the interest rate. Since finance charges are directly related to interest rates, as an individual has a lower interest rate, then their finance charges will be lower than those who pay higher interest rates. By lowering your interest rates, cardholders can lower their payments.
If you would like to have a lower interest rate, you need to improve your credit score. This can possibly be done by paying down debt, creating a budget to pay bills on time, and developing a habit to check and correct your credit reports. This will help boost your credit score, but also help develop better financial practices.
The other factors that can affect financial charges are when credit holders pay the bill or use their cards. Banks will also include late fees and foreign transaction fees in the finance charge, so your finance charge could increase if you use your card while traveling abroad or miss a payment.
How to Avoid Paying Finance Charges
It is important to first understand how you can incur a charge. Those who carry a debt or do not pay their balance in full each month will always have to pay a finance charge. If you cannot pay off your balance, try transferring your balance to another card with a 0% APR promotion.
There are also other ways finance charges can occur, such as if card issuers charge fees for balance transfers, cash advances, or purchases in foreign countries. In order to avoid paying these fees, try to avoid activities such as the ones listed above. For example, if you travel often, try finding a card that offers no foreign transaction fees.
Lastly, when you are reviewing your credit card billing statement, loo closely to ensure you are being charged properly for any outstanding balance. As you examine the charge, it will also help you know how much you will need to pay to eliminate your credit card debt.
A finance charge is the interest fee that is charged on debt you owe from credit accounts. It can leave you spending more than intended, so be sure to avoid activities that cause you to incur fees.
For more information on banking, check out more bank guides right here on HMB!
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