Calculating Finance Charges. When missing a payment, your next billing statement will include a finance charge. Finance charges are calculated using different methods, one of them is the Daily Balance Method.
The daily balance method of Calculating Finance Charges uses the actual balance on each day of your billing cycle instead of an average of your balance throughout the cycle. Finance charges are calculated by summing each day’s balance multiplied by the daily rate, which is 1/365th of your APR. Stated another way, the daily rate is your APR divided by 365.
Daily Balance Method Calculation Example
Here’s an example of how a finance charge would be calculated using the daily balance method. For simplicity, this example assumes you have the same balance every day of the billing cycle.
APR = 14%
daily rate = .0385%
days in billing cycle = 30
daily balance = $1000
finance charge = (Day 1 balance * daily rate) + … + (Day 30 balance * daily rate)
= ($1000 *.000385) + … + ($1000 * .00385)
Effect of Payments
With the daily balance method, the timing of your payments and charges makes a difference in the amount of your finance charge.
Consider the same APR, daily date, and days in the billing cycle as above.
If you make a $100 payment on the 5th day of the billing cycle, your finance charge would be $10.55. But, if you made a $100 payment on the 25th day of the billing cycle, your finance charge would be $11.32.
Making your payment early in the billing cycle means you have a lower balance for more days in the billing cycle. It results in a lower finance charge in that situation.
Let’s say you make a payment ($100) and a charge ($75) during the same billing cycle. Look at how the timing of each affects your finance charge:
Payment on 5th, the charge on 25th, finance charge = $10.69
Payment on 5th, the charge on 6th, finance charge = $11.27
If you pay on 25th, charge on 5th, finance charge = $12.11
Payment on 24th, the charge on 25th, finance charge = $11.46
You see, making payments early in the billing cycle and charges later in the billing cycle result in a lower finance charge when your credit card uses the daily balance method to calculate finance charges. Making changes early in the billing cycle and the payment later in the billing cycle results in the highest finance charge.
Tracking the timing of your payments and charges would be important if you want to reduce the amount of interest you pay on your credit card account (then again, you can eliminate finance charges by paying your balance in full each month).
If you want to keep up with the days in your billing cycle, you need to know when your billing cycle starts and the number of days in the billing cycle. You can find this information on your credit card statement.