There are six different ways that finance charges are calculated. They’re all based on some variation of your credit card balance during the billing cycle. Your balance is multiplied by your periodic rate rather than your annual percentage rate. The periodic rate is expressed on a monthly or daily basis.

Six Finance Charge Calculation Methods

1. Average Daily Balance

The average daily balance method of calculating finance charges is the method that’s most commonly used. In this method, your creditor averages your balance for each day during your billing cycle. Then, the average is multiplied by your annual percentage rate and the number of days in the billing cycle and the final number is divided by 365. The calculation looks like this:

( Average daily balance * APR * number of days in billing cycle )/365

2. Daily Balance Method

To calculate your finance charge using the daily balance method, your credit card issuer multiplies the balance on each day in the billing cycle by the daily rate to come up with a daily finance charge. Then, the daily finance charges are added together for your finance charge for the month. The daily rate is your annual percentage rate divided by the number of days in the year.

3. Ending Balance Method

If your credit card issuer uses the ending balance method to calculate your finance charge, then the balance at the end of your billing cycle is multiplied by the periodic rate to come up with your finance charge. To calculate your ending balance, your card issuer takes the balance at the beginning of your billing cycle then subtracts credits and payments and adds fees and new charges.

4. Previous Balance Method

The previous balance method multiples your balance at the beginning of the billing cycle by the periodic rate. Any payments or charges you make on your credit card during the billing cycle won’t affect your finance charge, at least not in this billing cycle. The balance at the end of your current billing cycle will be the balance at the beginning of your next billing cycle. So what you charge this month will impact the finance charge you pay next month.

5. Adjusted Balance Method

The adjusted balance method begins with the balance at the beginning of your billing cycle. The balance is adjusted based on any payments or credits made during the billing cycle. That adjusted is multiplied by the periodic rate to come up with your finance charge. You won’t pay a finance charge on charges you make during this billing cycle until the next billing cycle.

6. Double Billing Cycle Method

The double billing cycle method of calculating finance charges is the most expensive method of calculating finance charges. The calculation method is exactly like the average daily balance method of calculating finance charges, except the average daily balance from the current and previous billing cycles are used. That means, you end up paying interest on balances that have already been paid.

Fortunately for credit cardholders, a federal law that becomes effective February 22, 2010 bans the double billing cycle method of finance charges.

Which Method Does Your Card Issuer Use?

Federal law requires credit card issuers to give include details about the finance charge calculation on your billing statement. Refer to the back of your billing statement for details on which finance charge calculation method your card issuer uses. Your billing statement will describe how your finance charge is calculated even if it doesn’t specifically name the calculation method as we did in earlier in the post.

How to Avoid a Finance Charge

Finance charges are applied to balances that you carry beyond the grace period. You can avoid paying a finance charge by paying your balance in full before the grace period expires. Because credit card issuers are currently required to mail your billing statement 14 days before the due date, you may have to pay your balance before the billing statement comes. (As of February 22, 2010, billing statements must be mailed at least 21 days before the due date.)

You can only avoid a finance charge if you had a $0 balance at the beginning of the billing cycle. Otherwise, you won’t have a grace period and won’t be able to avoid the finance charge.

Cash advances and balance transfers typically don’t have a grace period. Instead, those balances begin incurring interest the day the transaction is complete. Unfortunately, you won’t be able to avoid a finance charge on either of those transactions. You can reduce the finance charge you owe by paying the balance sooner rather than later. That’s actually better in this situation since cash advance and balance transfer balances have a higher interest rate.

The finance charge for purchases, cash advances, and balance transfers are all calculated separately.

Related posts:

1. 5 Reasons to Avoid a Credit Card Cash Advance
2. The 8 Most Important Credit Card Terms
3. 10 Ways to Avoid Credit Card Debt

What is a balance transfer?

A credit card balance transfer is the process of moving one credit card balance to another. You can move an entire credit card balance or just part of one. People often transfer balances because they want to take advantage of the newer credit card that happens to have a lower interest rate or other fees.

The most attractive balance transfer offers are typically made to people with very good credit scores. These people with credit scores in the 700s and 800s often receive balance transfer offers for 5% interest rate or less.

The low interest rate balance transfer won’t last forever. These promotional rates typically expire anywhere from three months to a year. Starting February 22, 2010, any promotional interest rate must last at least six months.

Once the promotional balance transfer interest rate expires, the interest rate on the balance transfer will go up to the regular transfer rate. That rate will probably be significantly higher than the promotional rate. The regular average balance transfer interest rate is around 13%.

The Cost of a Balance Transfer

Balance transfers are not without their costs. When you make a balance transfer, you’ll be charged a balance transfer fee. It could be a flat fee or a percent of the amount you transfer. Watch out for the balance transfer fee. It could be so high that it negates any interest savings you receive.

If you’re wondering whether you’ll save money with a balance transfer, plug your numbers into a balance transfer calculator like the one from CreditCards.com. The calculator may reveal that the balance transfer deal isn’t going to save money after all.

Make the most of a credit card balance transfer.

To take full advantage of a balance transfer deal, you should pay off all (or at least most) of your transferred balance during the promotional period. That way you’re not stuck paying off the balance at a much higher interest rate.

When you transfer a balance to a credit card, don’t make any charges on the credit card until the balance transfer has been completely repaid. For now, any payment over the minimum goes toward the balance with the lowest interest rate. If your purchases APR is higher than your balance transfer APR (after the promotional rate expires) that means your payments will go toward paying off your purchase while the balance transfer continues to accrue interest at the higher interest rate.

Note that after February 22, 2010, credit card issuers won’t be able to apply payments this way anymore. Instead, they’re required to put any payment over the minimum toward the balance with the highest interest rate. That’s a little better. However, you still have a balance that’s accruing interest and not being paid off.

Choosing the Right Balance Transfer Credit Card

When you’re look at balance transfer credit cards, there are a few things you should consider.

• The promotional interest rate and how long it lasts. This is one of the most important pieces of a good balance transfer deal. You want to get the lowest interest rate for the longest period of time.
• The balance transfer APR that applies after the promotional rate ends. If you don’t completely repay your balance transfer before the promotional rate ends, your balance will be subject to the regular interest rate for balance transfers. If this interest rate is higher than the rate you were previously paying, question whether it makes sense to take the offer.
• The balance transfer fee influences how much you pay for the balance transfer. The lower the fee, the better. The higher the fee and the higher the balance you’re transferring, the more expensive it gets to transfer your balance.
• Whether the card has an annual fee. The annual fee is another factor that can increase the cost of your balance transfer, especially if your current credit card doesn’t have an annual fee.
• The number of balances you can transfer. You might want to use the promotional rate to help pay off several credit cards. Read through the balance transfer promotional details to see if there are any restrictions on the number of balances you can transfer. Of course, you may also be limited by your credit limit. If your credit limit isn’t high enough to cover all your credit card balances, some of them will have to be left behind.

Balance Transfer Tips

Be careful about opening too many new balance transfer credit cards. Each time you apply for a credit card an inquiry is placed on your credit report. All the extra credit report inquiries could make it difficult to get credit cards and loans in the future.

Use balance transfers to take advantage of a lower interest rate, not to avoid making your credit card bill. Those balance transfer fees start adding up, increasing your balance increase, and eventually the payments will catch up with you.

Related posts:

1. How To Eliminate Credit Card Debt Using A Balance Transfer Credit Card