Apply the finance charge calculator to estimate the cost imposed on your outstanding credit balance incurred over a billing cycle or given term.
Read further, and you will learn what the finance charge definition is, how to calculate finance charge, what is the finance charge formula, and how to minimize it on your credit card.
What is finance charge?
A finance charge is the total dollar amount you pay to use a particular credit. Therefore, we may phrase the finance charge definition as the amount paid beyond the borrowed amount. It includes not only the interest accrued on your account but also takes into account all fees connected to your credit. Therefore, finance charge represents the cost of borrowing. Finance charges are generally attached to any form of credit, whether it's a credit card, personal loan, or mortgage.
The most typical way consumers obtain credit are through credit cards. When you don't pay off your balance fully, your issuer will charge interest on the outstanding balance. That interest cost is a finance charge. If you miss the due date after the grace period without paying the required minimum payment for your credit card, you might be charged a late payment fee, which is another example of a finance charge.
How to find finance charge? Six ways to calculate finance charges
Credit card issuers may apply one of the six different methods to calculate finance charges.
- Average Daily Balance: This is the most common way, based on the average of what you owed each day in the billing cycle.
- Daily Balance: The credit card issuer calculate the finance charge on each day's balance with the daily interest rate.
- Adjusted Balance: It subtracts your monthly payment from your opening balance. Since purchases are not included in the balance, this method results in the lowest finance charge.
- Double Billing Cycle: It applies the average daily balance of the current and previous billing cycles. It is the most expensive method of finance charges. The Credit CARD Act of 2009 prohibits this practice in the US.
- Ending Balance: The finance charge is based on your balance at the end of the current billing cycle.
- Previous Balance: It uses the final balance of the last billing cycle in the calculation. Try to avoid credit card issuers that apply this method, since it has the highest finance charge among the ones still in practice.
Note that you can apply the present finance charge calculator for most of the above methods (except Daily Balance methods) - you only need to be careful when determining the balance you owe at the beginning of the computation.
How to calculate finance charge? Finance charge calculator
By following the below steps, you can quickly estimate finance charge on your credit card or any other type of financial instrument involving credit. Say you would like to know the finance charge of a credit card balance of 1,000 dollars with an APR of 18 percent and a billing cycle length of 30 days.
- Convert APR to decimal:
APR / 100 = 18 / 100 = 0.18
- Calculate the daily interest rate (advanced mode):
Daily interest rate = APR / 100 / 365
Daily interest rate = 0.18 / 365 = 0.00049315
- Calculate the finance charge for a day (advanced mode):
Daily finance charge = Carried unpaid balance * Daily interest rate
Daily finance charge = 1,000 * 0.00049315 = 0.49315.
- Calculate the finance charge for a billing cycle:
Finance charge = Daily finance charge * Number of Days in Billing Cycle
Finance charge = 0.049315 * 30 = 14.79.
To sum up, the finance charge formula is the following:
Finance charge = Carried unpaid balance * Annual Percentage Rate (APR) / 365 * Number of Days in Billing Cycle.
How to minimize finance charge on your credit card?
The simplest way to reduce finance charge is to avoid accruing interest on your balance. For that, you need to pay your outstanding credit balance in full before the due date, so you don't get charged for interest.
Credit card issuers offer a so-called grace period, a a specific number of days when interest is not charged, often 44 to 55 days. During such an interval, you have time to pay your credit without incurring interest during the grace period. It is still advisable to repay your credit in the given billing cycle: any balance carried into the following billing cycle implies losing the grace period privilege. You can regain it only if you pay your balance in full during two successive months.
Also, keep in mind that, in general, the grace period doesn't cover cash advances. In other words, there are no interest-free days, and a service fee may apply as well. Interest on cash advances is charged immediately from the day the money is withdrawn.
In summary, the best way to minimize your finance charge is to avoid cash advances and pay your credit card bills in full each month.
The results of the finance charge calculator should be considered as an approximation financially. Therefore, we created the calculator for instructional purposes only. Yet, in case you experience a relevant drawback or encounter any inaccuracy, we are always pleased to receive useful feedback and advice.