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Revolving Credit Making Your Head Spin?
By Jill Terry
 You've
shopped around and found a credit card with a great low rate.
Unfortunately, depending on how the credit card company or
bank calculates its finance charges, you may not be saving
as much as you think.
There are at least four different ways of calculating a finance
charge, with lots of variations on those methods, so a rate
of 5% at one bank may translate to a different monthly figure
than 5% at another bank. If you can't find the balance computation
method on the literature included with your application or
new account materials, be sure to ask someone (call the toll
free number that's usually part of the package--and be willing
to wait out transfers until you reach someone with enough
training to know what you're looking for).
Here's a quick primer on how these calculations are made
and what they mean to your budget. (To bring each method to
life, we'll plug in the same scenario into each method so
you can see how the calculation might actually affect you:
The bank says that in the month of May, your average daily
balance was $100. On June 1, day one of the new billing cycle,
your balance is $175. On June 10, you make a payment of $65
and on June 15, you make a purchase of $50, ending up with
a balance of $160.)
- Method 1:
Average daily balance (including new purchases):This
balance is figured by adding the outstanding balance (including
new purchases and deducting payments and credits) for each
day in the billing cycle and then dividing by the number
of days in the billing cycle.
Balance was:
$175 for 10 days ($175 x 10 = $1750)
$110 for 5 days ($110 x 5 = $550)
$160 for 15 days ($160 x 15 = $2400)
$1750 + $550 + $2400 = $4700 divided by 30 days is $156.67.
Finance charge rate would be applied to $156.67.
Bottom line: New purchases are immediately part of
the balance used to calculate the finance charge. Unless
you're using the card only as a balance transfer vehicle
and never intend to make any purchases, this method is not
ideal (but it's better than many!).
- Method 2:
Average daily balance (excluding new purchases): This
balance is figured by adding the outstanding balance (excluding
new purchases and deducting payments and credits) for each
day in the billing cycle, and then dividing by the number
of days in the billing cycle.
Balance was:
$175 for 10 days ($175 x 10 = $1750)
$110 for 20 days ($110 x 20 = $2200)
$1750 + $2200 = $3950 divided by 30 days is $131.67.
Finance charge rate would be applied to $131.67.
Bottom line: The clear winner. New purchases are
not figured into the average daily balance so you get a
little free ride time on what you buy.
- Method 3:
Two-cycle average daily balance (including new purchases):
This balance is the sum of the average daily balances for
two billing cycles. The first balance is for the current
billing cycle and is figured by adding the outstanding balance
(including new purchases and deducting payments and credits)
for each day in the billing cycle and then dividing by the
number of days in the billing cycle. The second balance
is for the preceding billing cycle.
June balance was:
$175 for 10 days ($175 x 10 = $1750)
$110 for 5 days ($110 x 5 = $550)
$160 for 15 days ($160 x 15 = $2400)
$1750 + $550 + $2400 = $4700 divided by 30 days is $156.67.
Finance charge rate would be applied to $156.67 for month
of June and $100 for month of May = $256.67.
Bottom line: This method is a nice double-whammy
for anybody who regularly uses a credit card for purchases
and carries a balance from month to month. You effectively
pay for activity twice because the calculation method considers
the current and previous month's average daily balances.
Unless you pay off your balance every month, steer clear
of this method.
- Method 4:
Two-cycle average daily balance (excluding new purchases):
This balance is the sum of the average daily balances for
two billing cycles. The first balance is for the current
billing cycle, and is figured by adding the outstanding
balance (excluding new purchases and deducting payments
and credits) for each day in the billing cycle and then
dividing by the number of days in the billing cycle. The
second balance is for the preceding billing cycle.
June balance was:
$175 for 10 days ($175 x 10 = $1750)
$110 for 20 days ($110 x 20 = $2200)
$1750 + $2200 = $3950 divided by 30 days is $131.67.
Finance charge rate would be applied to $131.67 for month
of June and $100 for month of May = $231.67.
Bottom line: While not as gouging as Method 3, Method
4 is still not a good deal for anybody who doesn't pay balances
in full each month because it counts each month's activity
twice.
Final note: Beware of minimum finance charges. Sometimes
these so-called "minimums" are actually higher than what you'd
pay if calculations were based only on your balance. If you
tend to run high balances, this may not be an issue for you,
but if you use your card moderately or rarely (yet still carry
a balance), minimum finance charges will drive up your monthly
payment unnecessarily. Your disclosures should tell you if
minimum finance charges are imposed.
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