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What Are Finance Charges?

Feb 4, 2008
Regardless of the type of credit card that you are using, chances are excellent that it carries with it some form of finance charge. Unfortunately, many credit card companies do not spend a lot of time explaining, in clear language, just how these finances charges affect your monthly bill. Most accountants can probably figure it out, but average consumers often have a harder time with it. So, what exactly are finance charges?

A finance charge as it applies to a credit card is the amount of money that the card issuer is going to charge you when you use the card to make purchases. There are other monetary values on a statement as well such as the purchase amounts of things you charged during the billing period. These other values are used when the company is calculating your finance charge for the monthly bill.

One of the best tips for using credit cards is to either reduce or even eliminate the finance charges. You can eliminate finance charges altogether by simply paying your balance off each month within the grace period allowed by the company. If you do not carry over a balance, you will not be charged interest. It is only when you do not pay off the full amount and some (or all) of your purchases are carried over that you are charged the interest on the amount carried over.

A good way to reduce the amount you have to pay on finance charges is to reduce the amount that you charge each month. This is only common sense, but many consumers can save a lot of money each month by simply paying cash for many items, especially if they are in the habit of carrying over a balance.

Finance charges are calculated by using the amount of your outstanding balance and the APR that applies to the card. The APR is the Annual Percentage Rate. Consumers should understand that the ARP can vary from one company to the next, and it can even vary within the same company.

There are several ways that credit card companies can calculate the finance charges that they apply to consumer credit. In addition to using the cards with the lowest APR's you should also use the card that best suits your needs in terms of finance charge method.

Some companies will use one billing cycle for figuring out finance charges, others will use two. Some companies may use the previous balance as the basis for finance charges while others may use the average daily balance. Still, some companies will either include or exclude new purchases on the current balance. All of this makes a difference and consumers should investigate the method that their credit card uses as this can save money over the long run.

You will normally find that you have a lower finance charge when the company uses what is known as one-cycle billing and uses the average daily balance method which excludes new purchases. Much of this, however, depends on the balance and the time of the month that you make purchases and payments.

The next lowest finance-charge method that some companies use is the adjusted balance, followed by the previous balance method. You can see which method the company is using by reading the bill that you receive. This information is written on the reverse of your statement.

It is also important that you understand that some companies will have a minimum finance charge system. When a credit card company uses this system you will be charged that minimum amount even if your finance charge is less than that amount.
About the Author
Peter Kenny is a writer for The Thrifty Scot, please visit us at Loan and Credit Cards
Visit Are you suffering from financial hangover?
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