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Credit Card Financing (Page 3 of 3)

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Summary:
Credit Cards love to make things hard when it comes to calculating interest. This article looks at what Average Daily Balance, Adjusted Balance and Previous Balance calculations mean and what method is best to borrow money.

Getting Technical With Interest Calculation

Borrowing money using a Credit Card is simple enough, on the outside. But the inner workings are often far more complex. They are often made more so by different ways of calculating the interest bill on debit balances.

It is therefore possible that a card with an APR of 14% is more expensive to borrow on than a card with an APR of 18%.

Three Main Methods of Calculating Interest

1. Average Daily Balance

  • This is the most common calculation method for credit card interest

  • The issuing company tracks your balance day by day alongside adding charges (purchases) and subtracting payments as they occur

  • To get your finance charge they take the average of the daily totals and multiply this by the monthly interest rate

  • While new purchases may or may not be added to the balance, depending on your plan (see illustration on the next page), cash advances are included

  • Example: Add the balance for each day during the billing cycle and then divide by the number of days in the billing cycle

  • For the first 15 days of the billing cycle you have a balance of zero (£)

  • Then on the 16th day (of a 30-day billing cycle) you buy something for £1,000

  • Your average daily balance would £1,000 ([£0 x 15 days] + [£1,000 x 15 days] = £15,000 / 30 days = £500)


2. Adjusted Balance

  • This is usually the most advantageous method for credit card holders

  • Your balance is taken from your previous statement, new charges are added (purchases etc), payments that you made are subtracted

  • This figure is multiplied by the monthly interest rate

3. Previous Balance

  • This considers the amount that you owed at the end of the previous billing period

    Payments, credits and new purchases during the current billing period are not included

  • This means that you can still be charged interest on your debit balance even after you've paid it off!

  • The previous balance method is a classic example of just how sneaky most finance firms are and why it pays dividends to never forget this fact

If you don't understand how your balance is calculated, ask your credit card provider. An explanation must also appear on your statement and in the small print.

Interest Rate Calculation Conclusions

  • Adjusted Balance calculations for interest bills are clearly the best for credit card holders that regularly carry unpaid balances forward

  • Average Daily Balance strike a fair balance between the card holder's interest and the card companies' interests

  • Previous Balance is bad news for Credit Card holders and in many ways seems unfair

To get a clear picture of which card is best for those that borrow money on their plastic you have to understand a little bit of the inner workings.

A card for example that offers an APR of 13%, but uses the Previous Balance method of interest calculation can be more expensive than a card that has an 18% APR that uses the Adjusted Balance method.

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