Figure Out Finance Charge - Financial Steps

Understanding finance charges is crucial for anyone using credit, whether it’s a credit card, a loan, or even a store account. The finance charge represents the total cost of borrowing money, encompassing interest and sometimes other fees associated with the loan. Let’s break down how to figure out what that charge is.

Identify the Interest Rate: The first step is knowing the interest rate applied to your balance. This is usually expressed as an Annual Percentage Rate (APR). The APR reflects the yearly cost of borrowing, but remember that interest is often calculated and charged monthly.

Determine the Calculation Method: Lenders use different methods to calculate finance charges, so understanding which one is being applied to your account is key.

Average Daily Balance: This is the most common method. The lender calculates the daily balance throughout the billing cycle, adds up all those daily balances, and then divides by the number of days in the cycle. This gives you the average daily balance, upon which the interest is calculated.
Previous Balance: This method calculates interest on the balance at the beginning of the billing cycle, *before* any payments or purchases are made. This is generally the most expensive method for the borrower.
Adjusted Balance: This calculates interest on the balance at the beginning of the billing cycle, *after* subtracting any payments made during the cycle. It’s more favorable to the borrower than the previous balance method, but less favorable than the average daily balance method.

Calculate the Periodic Interest Rate: Once you know the APR, you need to convert it to a periodic rate. For most credit cards, this means dividing the APR by 12 to get the monthly interest rate. For example, an APR of 18% would translate to a monthly interest rate of 1.5% (0.18 / 12 = 0.015).

Apply the Interest Rate: With the monthly interest rate and the balance (determined by the calculation method), you can finally calculate the finance charge. Multiply the balance by the monthly interest rate. For example, if your average daily balance is $500 and your monthly interest rate is 1.5%, the finance charge would be $7.50 ($500 * 0.015 = $7.50).

Factor in Additional Fees: The finance charge might include more than just interest. Some lenders charge annual fees, late payment fees, cash advance fees, or over-the-limit fees. These fees should be clearly stated in your credit agreement and will be added to the total finance charge.

Review Your Statement: Your credit card statement or loan statement should detail how the finance charge was calculated. Look for sections labeled “Interest Charged,” “Finance Charge,” or similar terms. Carefully review the details to ensure accuracy and understand the breakdown of charges.

Use Online Calculators: Numerous online calculators can help you estimate finance charges. These calculators typically ask for the APR, balance, payment amount, and calculation method. While these calculators provide estimates, they can be helpful in understanding the impact of different factors on your finance charges.

By understanding these steps, you can gain a better grasp of your finance charges and make informed decisions about your borrowing habits. Keeping your balances low and paying them off on time are the most effective ways to minimize finance charges and save money.