The Low Down on a Credit Card Finance Charge

What is a finance charge? As defined by the government Truth in Lending Act, a "finance charge is the cost of consumer credit as a dollar amount. It includes any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as an incident to or a condition of the extension of credit. It does not include any charge of a type payable in a comparable cash transaction." So basically it is the dollar cost to borrow money.

All credit card companies charge you this dollar amount to borrow their money, unless of course, you have a 0% APR or pay your bill in full each month. These charges vary based on many factors. The factors include your annual percentage rate, credit card balance, grace period, and type of transactions. Let me break this up a little and explain the basics.

Annual Percentage Rate - My definition of annual percentage rate is the advertised percent that you borrow money at on an annual basis. The advertised APR does not include any fees and excess charges imposed by your credit card. See the example below to better understand what I mean by advertised...

For example, you have a $1000 balance transfer advertised at 0% APR for 12 months with a balance transfer fee of 3% ($30.00). Suppose you plan to pay it off in this timeframe. The $30.00 is truly tagged by the bank as finance charges, usually payable the first month. Your true annual percentage rate would be 3% for the year. You're paying $30.00 to borrow $1000.00. Lets say you get a late fee the next month of $39.00. There goes the effective APR up to 6.9% for the year. You're now paying $69.00 to borrow that same $1000.00. Make sense?

Credit Card Balance - A credit card balance is the sum of all purchases, balance transfers, and cash advances you have made with your credit card. A balance can affect your interest charges since they are based on a percent of the balance. Basically, the higher your credit card balance, the more you pay. Of course that is if you have the same rate on all your transaction types.

Grace Period - The 20 to 25 days after your credit card statement prints where no finance charges are assessed. If you choose to pay the balance in full before the due date, you will not see these charges. If you choose to pay just the minimum or only part of the balance, the grace period is taken away. You will then accrue finance charges from the date of the transactions on the bill up to the date they are paid in full. This calculation may include any new purchases made until the payment is received, depending on the bank! See examples of finance charge calculations.

Grace Period Definition

A grace period is not the amount of time after your payment due date that you have to get your payment into the credit card. All credit card payments are due on or before the due date printed on your statement. :-)

Transaction Types - Transaction types can affect the amount of finance charges you pay. Rates may be different on each type. Balance transfers usually have the lowest annual percentage rate. Many credit cards offer them as teasers to get you to sign up for a credit card. Secondly, purchases usually carry a median rate, anywhere from 8% to 20%. Cash advances cost you a high 20% to 30% APR depending on the bank. These rates can all of course vary depending on your payment history and credit bureau information.

As you can see, all these factors play an important role in determining your interest amount. Here's my best advice for saving money on credit cards. Transfer your balances you carry to a low rate credit card without a balance transfer fee, always pay your bill on time, pay sooner than later to avoid longer daily compounding, and finally avoid cash advances at all costs. On the cards you do pay in full each month just continue to pay them in full on time and you'll be good to go.

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