A person will be charged if they keep a balance on their credit card for more than one billing cycle. This is called a finance charge, and it is related to the APR on the consumer's account. How the card was used and how much was charged will affect how much will be charged. Even with Low Interest Credit Cards, it's important to know that rates change depending on how the card is used. For example, a new purchase will have a different APR than a cash advance or balance transfer.
Credit cards can be hard to understand, and most people who use them don't understand the fees that come with them. This can be risky and put some people in a downward spiral of debt that can be hard to get out of. Creditors should be more clear about what they offer, but it is up to the consumer to do the necessary research before signing any kind of financial contract. How interest is worked out is one of the more confusing things about credit cards.
The two most common ways to figure out interest on a credit card are:
- The Average of the Two Cycles
The daily average balance
The Two Cycle Average is:
This is the most common way to figure out the interest on a credit card, so it makes sense that it is also the most complicated. To figure out interest, you take the average of the amount charged to an account and divide it by the number of days in the current billing cycle and the billing cycle before that.
A good example would be if the consumer has $500 left over from the last billing cycle and the interest rate on the credit card is only 11%. Let's say the cardholder only pays $100 on their account for the sake of this example.
If the two-cycle average daily balance is used, the consumer must take an average of both the current balance and the balance from the previous day. Here's one way to look at it:
(Previous Balance + Current Balance)/2 Billing Cycles * 30 = (Amount Applied to Interest)*APR
Using the above numbers for our customer and assuming that both billing periods are 30 days, we get:
($1000.00 + $500.00) /60 *30 = $750.00.
Instead of paying interest on the current balance of $500, the person would pay interest on $700. This means you'll have to pay more interest, and it's clear that this method is better for the creditor.
Balance for the average day:
This method takes the total amount charged for new purchases over the number of days in a certain billing cycle and finds the average. An example would be if a person bought a chair for $400.00 and then a meal for $25.00 the following week. The average daily balance would be $14.17 if no more purchases were made during the current billing cycle. This should mean that the amount you pay in interest is the same whether you buy something on the first or last day of a billing cycle.
The best way to get the most out of a credit card is to never have a balance, but this isn't always possible. Carry a balance only when you have to, and only for as long as you have to.
