If you are not able to pay your balance in full at the end of a billing cycle, some credit card issuers give you a grace period. This normally lasts for some days before the next billing cycle. If you’re still not able to pay after the grace period, a finance charge is applied to your balance. This will reflect in your next bill.
There are basically six ways of calculating finance charges. Your credit card issuer’s method of calculating finance charges can be found on your recent billing statement. Finance charges aren’t a flat fee. Instead, the finance charge is calculated for each billing cycle based on your balance and interest rate. Generally, higher balances and interest rates result in higher finance charges.
01 Adjusted Balance Method | Calculating Finance Charges
The adjusted balance method of calculating finance charges starts with the balance at the beginning of the billing cycle and subtracts any payments you made during the billing cycle. Purchases are not included in the balance. Out of all the ways of calculating finance charges, this method results in the lowest finance charge. But not very many credit card issuers use it.
02 Average Daily Balance | Calculating Finance Charges
The average daily balance method uses the average of your balance during the billing cycle. Each day’s balance is added together and divided by the number of days in the billing cycle. New charges are sometimes excluded in the calculation of the average daily balance. This is the most common way of calculating finance charges.
If your credit card issuer calculates your balance using the average daily balance method, you can minimize your finance charges by paying your balance down earlier in the billing cycle.
03 Daily Balance Method | Calculating Finance Charges
The daily balance method is similar to the average daily balance method because it uses the balance each day of your billing cycle. However, instead of averaging the balance, each day’s balance is multiplied by the daily rate for a “daily finance charge.” Each day’s finance charge is totaled for the finance charge for that billing cycle.
04 Double Billing Cycle Method
The double billing cycle uses the average daily balance of the current and previous billing cycles. This is the most expensive way finance charges are calculated. It is unfair to cardholders because it charges interest on balances that have already been paid. Fortunately for credit cardholders, the double billing cycle method of calculating finance charges was outlawed with the passing of the Credit CARD Act of 2009.
05 Ending Balance Method
The ending balance method uses your balance at the beginning of the billing cycle minus payments plus charges made during the billing cycle – which is essentially your balance at the end of the billing cycle. The number of days in the billing cycle doesn’t affect the amount of the finance charge. Having a high balance at the end of your billing cycle would increase your finance charges under this method.
06 Previous Balance Method
The previous balance method uses the balance at the beginning of the billing cycle which is also the ending balance of the last billing cycle. No payments or charges are included in the balance. The number of days in the billing cycle doesn’t affect the amount of the finance charge.