What is a credit card finance charge?

Credit cards come with many rates and fees that cardholders should be aware of, and at the top of the list are finance charges. It’s one of the most common fees associated with every credit card, but many cardholders don’t know what it is or how it impacts the amount they pay each month.

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Unfortunately, cardholders who don’t bother to learn the definition of a finance charge leave themselves vulnerable to those same charges. The definition of a finance charge is, in simple terms, the interest you pay on a debt you owe. With credit cards, if you carry over a balance from one payment period to another, you’ll be charged finance charges — or interest — on that remaining balance..

Here’s an overview of what this credit card finance fee guide will cover:

• Definition of finance charges

• Interest vs finance charges

• How credit card financing fees are calculated

• Factors that affect finance charges

• How to avoid paying finance charges

Definition of finance charges

A credit card’s finance charge is the interest charged on revolving credit accounts. It is directly related to a card’s annual percentage rate and is calculated based on the cardholder’s balance.

Most cardholders aren’t aware of finance charges until they purchase an item. When they allow a portion of their balance to be carried over to the next month, fees apply.

The finance charge acts as a kind of convenience fee – a penalty that the credit card company imposes so that you don’t have to pay your balance in full each month. In short, as long as you keep a balance, you will face finance charges.

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Interest vs finance charges

Interest is a type of finance charge that cardholders must pay if they have a balance on their credit cards. Finance charges may also include other transaction fees in addition to interest, including account maintenance fees and late fees in addition to interest. Interest rates vary between cardholders and card issuers, and finance charges vary accordingly.

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How credit card financing fees are calculated

Unlike a mortgage or car loan which has a predetermined repayment plan, credit card financing fees can change from month to month. Finance charge is usually calculated by dividing your APR by 365. Then you multiply the resulting credit card rate by your outstanding balance. Unfortunately, that’s where the generalizations end.

Depending on the company, your finance charge may be calculated using one of the following methods:

• Average daily balance: The most commonly used method is the daily balance. It takes the average of your balance over the billing cycle, adding each day’s balance and dividing by the number of days in the billing cycle.

• Daily balance: The daily balance method uses the credit card balance of each day in your billing cycle, then multiplies each day’s balance by the daily rate. Then all the days are added up to get your load.

• Closing balance: The ending balance method takes your starting balance and subtracts payments plus fees made throughout the billing cycle.

• Previous balance: The previous balance method pulls your balance at the start of the billing cycle – which is the same as the ending balance from the last billing cycle – but charges and payments during the billing cycle do not affect the finance charge calculation .

• Adjusted balance: This method uses the balance you carry at the start of the billing cycle and then subtracts all the payments you make throughout the month. This calculation method is generally the least expensive for cardholders.

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Factors that affect finance charges

Several factors can affect the finance charges consumers pay. The first – and arguably the most important – is the interest rate. The individuals who benefit from the lowest interest rates pay lower finance charges than those who pay higher interest rates. By lowering their interest rates, consumers can reduce their payments.

To benefit from the lowest interest rates, consumers must take steps to improve their credit scores. They may need to pay off their debts, create a budget to pay their bills on time, and get into the habit of regularly checking and correcting their credit reports. Not only that increase credit scorebut it also helps establish better financial practices.

Other factors that influence finance charges include when credit holders pay the bill and when they use their cards. Banks include late fees and foreign transaction fees in finance charges. Missing a payment or paying expenses while on an international vacation can increase finance charges.

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How to avoid paying finance charges

To avoid paying finance charges, cardholders must first understand which actions incur charges. Those who don’t pay their balances in full every month are still paying a finance charge for the privilege of carrying the debt. If it is not possible to repay the balance, cardholders can take advantage of an offer to transfer balances to another card with a 0% APR promotion.

However, carrying a balance is not the only way to accrue finance charges. Some card issuers charge fees for balance transfers, cash advances and purchases abroad. Those who do not want to pay these fees should avoid the activities that trigger them. For example, a cardholder who frequently travels abroad may want to find a card that carries no foreign transaction fees.

When reviewing your credit card account statement, you should take a close look at finance charges to ensure that you are correctly billed for any outstanding balances. Reviewing these fees also helps you determine how much extra you will need to pay to eventually eliminate your credit card debt.

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Last update: October 12, 2021

This article originally appeared on GOBankingRates.com: What is a credit card finance charge?