How Are Finance Charges Calculated?

Whether you are shopping for a new credit card or wondering about the one that you may already have, knowing how to calculate the finance charge applied to that card is important. First, however, it is equally important to know what finance charges really are.

A credit card finance charge is the amount of money that you pay to the credit card company in order to use their credit. This is not the same as the purchase amount balance. The purchase amount balance is the dollar amount of the purchases that you made using the card. If you pay off the purchase amount balance within the stated amount of time that the company allows, you will have no finance charges applied to the amount. It is when you carry over your balance that finance charges are triggered and added to your account.

Finance charges are calculated using the amount of your outstanding balance and APR. The APR is the Annual Percentage Rate and all credit cards use them to figure finance charges. It is important for consumers to understand that the ARP can vary from one company to the next, and it can even vary within the same company. It is for this reason that consumers should always look for the companies with the lowest APR’s. This will save you money in the long run.

There are several ways that credit card companies can calculate the finance charges that they apply to consumer credit. Many people do not realize it but the method that is used can make a difference in the amount of money that you will have to pay. Here are some of the methods that credit card companies use to figure finance charges on your outstanding balance:

They can calculate using one billing cycle or two billing cycles.

They can use the adjusted balance, previous balance, or the average daily balance.

They can exclude or include new purchases in the balance.

You will normally find that you have a lower finance charge when the company uses what is known as one-cycle billing and uses the average daily balance method which excludes new purchases. Much of this, however, depends on the balance and the time of the month that you make purchases and payments.

The next lower finance charge method is the adjusted balance, followed by the previous balance method. You can see which method the company is using by reading the bill that you receive. This information is usually contained on the back side.

It is also important that you understand that some companies will have a minimum finance charge system. When a credit card company uses this system you will be charged that set amount even if your calculated finance charge is less than that amount.

Of particular importance to some credit card holders are the cash advance programs that come with some cards. Consumers should be very careful when using credit cards for cash advances. Many companies that offer cash advances treat those advances differently than they do purchases. Before you use your credit card for a cash advance, make sure you look for the details of how you will be charged for that advance.

You will certainly want to know what the APR is for cash advances. Keep in mind that this may be significantly higher than the APR that is used for purchases. You should also investigate the fees that may be applied to the transaction. Fees are in addition to the finance charge that you will have to pay.

Lastly, find out how your payments will be credited. Some companies will apply your payments to your purchases first and then to any advances in cash that you have taken.

Use your credit card wisely and keep track of your finance charges and you will enjoy your credit more fully and avoid some of the pitfalls that many consumers experience.

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Finance Charges: They’re What?

As a borrower compares interest rates from one lender to another when making a decision about which mortgage company to use, the process can be a bit confusing, to say the least. However, the federal government, in all their wisdom, issued a directive for all consumer loans to disclose the Annual Percentage Rate, or APR, to help the borrower compare loan offerings.

The APR is defined as the cost of money borrowed expressed as an annual rate and takes into consideration not only the interest associated with the loan but additional fees needed to close the loan as well. For example, a 30 year mortgage loan at 4.00% on a $200,000 note results in a $954 monthly payment. If the lender also charged a $2,000 origination fee, the APR figure is 4.08. If the lender charged $4,000 in origination fees the APR is 4.17. The higher the lender charges the greater the disparity between the interest rate on the loan and the APR number.

But what are those fees used to help calculate the APR? They’re called finance charges. And all lenders have them.

Finance charges are fees charged directly by the lender or are charges for services required by the lender in order to issue a mortgage loan. A lender can have a $500 processing fee, a $400 underwriting fee and a $2,000 origination charge. Those fees, charged by the lender for lender-performed services are included in the finance charges.

A lender will require several reports before issuing a mortgage yet not perform those services themselves. For example, a credit report and an appraisal will be a required report but performed by third parties. Since the lender will require certain third party reports those third parties will provide the requested information but the borrower will ultimately be responsible for paying them.

The greater the amount of finance charges, the higher the APR number will be compared to the interest rate. Even if two lenders offer the same mortgage rate, they can have two different APR numbers. The lender with the lowest APR in this example will have lower closing costs compared to the other lender. This is how you compare loans from different lenders. Notice the APR and understand how it’s calculated.

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