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Credit Card Interest Charges - How They Are Determined

Aug 17, 2007
'He who pays wrong, pays twice' is a famous saying amongst lawyers. Relating this to credit cards drives home its meaning even more. After your card-swiping shopping spree, it is payback time for all credit card users. However, if the rates are not calculated properly, one may end up paying the wrong amount.

Before getting into any calculations, did you know there is a difference, or rather a similarity, between the interest charge and the interest rate? The interest charge would be based on the percentage of the balance, or in other words, the interest rate.

If that is confusing, let us use a small example to clarify this. Suppose you have a balance of $1000, if you multiply it with an interest rate of about 18 %, it would result in a total interest charge of $180 for the whole year. Since the balance varies from time to time, your interest charge will not be constant

There are several ways credit card interest charges are determined. Credit card companies should state the method of calculating your interest in the terms and conditions furnished. Even if it is an insignificant variation, the methods do make a difference to credit card users.

How to Determine Credit Card Interest Charge

The annual percentage is the primary key to comparing credit products. Since the interest is computed on a monthly basis, to calculate the credit card charges, the annual percentage rate needs to be decompounded.

The methods to calculate credit card charges differ in different countries. The following are the methods listed according to the USA Regulation:

Adjusted Balance

To get the interest charge, the balance at the end of the billing cycle is multiplied by a factor. One could either get a lower or higher interest rate, as the time value given by the bank is not taken into consideration.

Average Daily Balances

Here, the sum of the daily outstanding balance is divided by the number of days included in the cycle to give the balance for that particular period. The amount is multiplied by a constant factor to the interest charge. Both the resultant interests are the same as the interest rate charged at the close of each day. Considered the simplest of the four methods, this method produces an interest charge very close to the expected one.

Two cycle average daily balance

As its name suggests, two billing cycles are taken into consideration and added to get the balance: the first being the current billing cycle, and the second the preceding billing cycle.

Breaking it up into two more sub-groups, it can be split into balance including new purchases and that excluding new purchases. The former group being a double-whammy for the regular credit card users, because the customer pays for the given activity twice, as the method considers the previous and current months' average daily balances. On the other hand, the second group is not suggested to those who do not pay their balances in full each month.

Previous Balance

This method favors the credit card company the most, as they base your monthly interest charge on the balance of the beginning or ending of the month. Similar to Adjusted Balance, this method could consequently result in a higher or lower interest rate than the one estimated. However, the part of the balance that is carried for more than two full cycles is charged at the rate expected.

Furthermore, be mindful that if there are multiple unrecognized charges on the bill, someone may have been accessing your number without your consent. This could prove risky in not only in calculating your interest charge, but will also burn a hole in your pocket.
About the Author
Joseph Kenny writes for CardGuide.co.uk, offering UK credit cards, visit them today for more best UK credit cards.
Visit today: http://www.cardguide.co.uk/
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