What is a finance charge on a credit card?
It's the end of your billing cycle and you sit down to review your monthly statement when you notice something called a finance charge, leading you to wonder, "What is a finance charge on a credit card? And is there any way to avoid it?" Let's learn more about which fees comprise finance charges, how to calculate them and how to avoid them.
What is a finance charge on a credit card?
In the simplest terms, a credit card finance charge is any charge associated with using your credit card. There are a number of different fees that contribute to finance charges, such as:
- Interest
- Late fees
- Cash Advance fees
- Foreign transaction fees
- Annual fees
- Balance transfer fees
Your minimum monthly payment is made up of a percentage of your balance, plus any finance charges you accrue. Finance charges can vary between issuers and cards. For example, some credit cards do not charge foreign transaction fees, while others might. If you aren't sure which fees your card is subject to, review your card's terms or reach out to your issuer's customer service line.
How to calculate the finance charge on a credit card
Your finance charge will vary from month to month, as it depends upon other variable factors, such as your account balance. There are also different methods to calculate your finance charge, depending on the issuer. If you aren't sure which formula to use, reach out to your issuer for clarification.
Average daily balance
The average daily balance method adds up each day's balance, and then divides that total by the number of days in the billing cycle to get an average. That number is then multiplied by 1/12 of your APR, or annual percentage rate (this number can be found in your card's terms). The result is your monthly finance charge. If you are looking to lower your finance charge, consider paying your balance throughout the month to help lower your daily balances.
Daily balance
The daily balance method is similar to the average daily balance, except instead of averaging out your daily balance throughout a billing cycle, it multiplies each daily balance by 1/365 of your APR. This results in a daily finance charge, which is then added together to get a monthly finance charge.
Previous balance
This method uses the balance carried over from your previous billing cycle to calculate your monthly finance charge. This method may be less advantageous to the cardmember if they prefer making payments throughout the billing cycle.
How to avoid finance charges on credit cards
There are a few things you can do if you're looking to avoid credit card finance charges.
- Pay your balance in full every month
- Apply for a 0% interest card.
- Be aware of fees and avoid things that incur them, such as cash advances.
- Use a card with no balance transfer fees.
- If you're traveling out of the country, use a card with low or no foreign transaction fees if possible.
- Apply for a card with no annual fee.
But don't fret — paying off your balance each month can be done with any credit card and can help you avoid those fees.
Additionally, if you have a card with a 0% APR introductory rate, be sure to mark on your calendar when that expires so you can avoid having a balance on your card when that time comes.
In summary
Finance charges are made up of many different things, so it's important to be educated about what fees your credit card is subject to. If you're hoping to avoid finance charges on credit cards all together, your best bet will likely be to make sure you're paying off your full balance each month.
