What is a finance charge?
A finance charge is any charge associated with borrowing money and paying it back over time. This includes accrued interest as well as additional fees related to borrowing, such as transaction fees. If you're wondering about the difference between a finance charge vs. interest, although they're similar in theory, a finance charge can include late fees or other charges as well as the interest fees.
With credit cards, your finance charge is the interest that has accrued on the money you owe during that particular billing cycle, plus any penalties, annual fees, transactions fees, and other fees. Most credit card issuers calculate interest charges by applying the annual percentage rate (APR) to your average daily balance.
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 the amount of time in the billing cycle.
There are a few possible ways credit card issuers can compute the interest portion of your finance charge, but most work it out 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, you'll figure out your average daily balance by looking at each day in your billing period (this range is listed on your statement). Take the balance of each day in your billing cycle, add them together, and divide by the number of days in that billing cycle. So, for example, if you have a $100 balance, but you charged $50 halfway through a 30-day billing cycle, you'd add up 15 $100 days and 15 $150 days to get $3,750. Dividing that by 30 gives you an average daily balance of $125 for that cycle.
- Last, take your average daily balance, $125, and multiply it by 0.049%, your daily interest charge, and then by 30, the number of days in your billing period to figure your interest charge. That looks like: $125 x 0.049% x 30, which equals $1.84.
It's important to note that the interest may be slightly different than this, depending on how frequently your credit card company compounds the interest. Some compound monthly, as is illustrated above, while others compound daily, which can make the math more complicated and the interest charge slightly higher.
It's also worth mentioning that many of the best 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 they can change over time along with a certain benchmark, such as the U.S. prime rate.
It's important to carefully compare credit cards before choosing to apply. That way, you'll know you have the best rate and terms possible, as well as bonuses or incentives that you will actually use.
