Finance charge simply refers to the interest that you are charged on a debt that you owe, and is generally used in the context of credit card debt. A finance charge is calculated using your annual percentage rate, or APR, along with the amount of money you owe and the time period that is being considered.
What is a finance charge?
Technically speaking, a finance charge is any charge that is included in the cost of borrowing money, such as accrued interest as well as fees related to borrowing the money, such as transaction fees. In practice, however, a finance charge is typically a synonym for "interest charge," although in some cases it can include late fees or other charges.
With credit cards, your finance charge is the interest that has accrued during that particular billing cycle on the money that you owe.
How your credit card finance charge is calculated
Your credit card finance charge depends on a few factors – specifically, your annual percentage rate, or APR, the amount of your debt, and how much time there was in the billing cycle.
There are a few possible ways that credit card issuers can compute your finance charge, but most compute it on a daily basis using the "average daily balance" method.
- First, your APR is divided by 365 (or 360 in certain cases) to determine your daily rate. For example, a credit card APR of 17.99% would translate to a 0.049% daily interest rate.
- Next, the daily interest rate is multiplied by the number of days in the statement billing cycle to determine your interest rate for each particular finance charge. Continuing the previous example, if there were 30 days in the billing cycle, a 17.99% APR would translate to an interest rate of 1.479% for the billing statement.
- Finally, this rate is multiplied by the amount of debt that is subject to your APR. If you owed $5,000 in our example, you would be assessed a finance charge of $73.95 on your billing statement.
It's also worth mentioning that many credit cards have promotional interest rates (more on that in the next section), as well as different APRs that apply to cash advances. Also, most credit card interest rates are variable, meaning that they can change over time along with a certain benchmark, such as the U.S. Prime Rate.
How to avoid paying finance charges on your credit cards
Other than the obvious answer of "don't charge anything on your credit cards," there are a couple of ways to actually use your credit cards and avoid paying finance charges.
First, by paying your credit card balance in full every month before your credit card's grace period runs out, you can avoid any finance charges. Most credit cards' grace periods are between 21 and 25 days, and you should be able to easily locate yours on your billing statement.
Alternatively, if you need to carry a credit card balance, there are many cards that offer 0% intro APRs for certain amounts of time. Many offers extend for 12 months or longer, and as I write this, there are 0% intro APR offers for as long as 21 months. With competition in the credit card industry at an all-time high, these offers are evolving quite rapidly, so be sure to check out the latest and best 0% intro APR offers. There are also some 0% intro APR offers specifically geared toward balance transfers, if you have an existing credit card debt that you'd like to avoid finance charges on.
During the card's promotional period, you won't be assessed any finance charges on qualifying purchases (generally, cash advances don't qualify), even if you carry a balance. Once the promotional 0% intro APR period ends, the balance will start to accrue interest at your standard APR.
Credit card finance charges can be rather high, with the average APR in the neighborhood of 15%. So, if you can avoid finance charges through one of the two methods discussed here, it could certainly be a smart move.
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