Calculation

How to calculate finance charge

How to calculate finance charge

As though it is good to calculate your own finance charge but your credit card report will certainly show you finance charge in case you have one. Learning to calculate your own finance charge can be useful anytime like cases where the bank is making mistake in your credit report. To calculate your finance charge, you must know the numbers of each of these; the APR, billing cycle, and the credit card balance. Finance charge cannot be calculated if you don’t have a significant figure on the interest rate, number like 0 on the interest rate makes it impossible for finance charge to be calculated.

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There are many ways in calculating the finance charge but let me start with the simplest method. If you have your billing cycle to be 3 months and your APR which is the Annual Percentage Rate to be 17% and the credit card balance to be $350. The first step is to  divide the APR by the billing cycle and multiply the result by the credit card balance, that is 17/3 = 5.67. So 5.67 * 350 which makes the monthly finance charge to be $1,984.5.

If your billing cycle is less than a month, it can be calculated using this method. The number of days of the billing cycle divided by 365 days multiply by the product of APR and the credit card balance. For example, if your APR is 17% with a billing cycle of 10 days and the credit balance is $350. Multiply the APR and the credit balance first which is 17% * $350 = 5,950. Then divide the billing cycle by 365 which is 10/365 = 0.027. Multiply the two figures together that is $5,950 * 0.027 = $160.65.

How to calculate finance charge

The interest rate is lower in the second example even though the credit balances and the APRs are the same, this is so because as the days get longer, the interest rate gets higher.

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There are other five ways the finance charge is mostly calculated which are the

  • Ending balance method: This is one of the simplest method used by banks to calculate the finance rate. This is done by using the balance at the end of the billing cycle. They make use of the final balance in the account at the end of the billing cycle.
  • Previous balance method: This is mostly used with ending balance method. This is usually calculated using the previous balance at the end of the billing cycle.
  • Adjusted balance method: This is done by subtracting the credit card balance at the beginning of the billing cycle from the payment that was done during the cycle. This can be slightly complicated to calculate.
  • The daily balance method: This is usually done by knowing the daily credit card balance and multiplying it with the each day billing cycle and multiplying the product with the Apr/365. Then you can add all the finance charge by the number of days. For example, if the daily credit balance is $10 and you have your APR to be 1%, to get your interest rate for the end of the 10 days billing cycle. You multiply $10 by 10 days which is $100. Divide you APR by 365 days which should give 0.0000273. Multiply the two products to give you $0.00273 that is 100 * 0.0000273 = $0.00273. The interest to be paid back is $0.00273.

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  • Most banks that issues credit cards often use the average daily balance method: This method is similar to the method of the daily balance but has a difference in which the daily balances is firstly averaged before you calculate the finance charge on that average balances. Knowing your daily credit card balance makes it easier for the calculation to be done because without knowing the daily credit card balance, it gets difficult to be calculated and might even not be able to be calculated. Get the finance charge balance for the number of days added up and get the total divided by the number of days in the billing cycle. Whatever you got from the calculation, get it multiplied by the APR and the number of days in the billing cycle again. Get the result multiplied by the number of days in the year which can be 365 or 366 days.
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Harish Yadav

Finance and market analyst and chief writer on howtofinance. Passionate to read books and articles on marketing and accounting. Also edits other articles and publish them here.

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