If you have spent any time at all researching credit card data and interest rate calculations, you probably found yourself feeling a bit dazed and confused. Certainly, now more than ever, consumers find themselves researching and having to develop and digest technically complex information and data not often presented in the easy to understand, laymen, terms most of us can easily comprehend.
The statistics supporting credit card debt accumulation and credit card usage has grown at a rate never before seen in history. We are truly living in a time never before been experienced in our relatively short history. With financial policy and governmental influences around the globe changing so radically throughout the last three or four decades the average consumer has effectively been removed from a comprehensible place of understanding and many have been lead to the very brink of financial ruin by their very own misguided and unintended ignorance.
You may think that you need a degree in accounting or economics to understand the credit card interest rate information you need today to make well informed and solid financial decisions but truly, you do not. You just need to understand how each of these calculations can affect how quickly or how slowly you pay off your credit cards. This information will also help you in deciding what credit card option may be the best choice for you.
Before we get to the five sorts of calculations used by financial organizations everywhere, you need to have a good understanding of how credit cards work. There are many advantages to using credit cards. They provide security in that you do not have to carry cash in your wallet. There are amazing consumer protections in place affording you options to disputing charges, protect against damaged or faulty merchandise as well as provisions against potential theft and fraudulent use of your charge cards. Just like modern currency, credit cards have many built in features designed to protect against counterfeiting and other forgery techniques used by innovative and creative thieves and forgers.
If you decide the credit card is the best way for to make your purchases, you should also assess what kind of spender you are. Are you a compulsive or impulsive shopper? Consider keeping a relatively low ceiling on your credit card limits. High limits along with impulsive spending habits could lead you down the road to financial ruin. The best way to use a credit card is to use it sparingly and pay your balance off each and every month. This way you avoid getting into unpaid balances and the interest valuations associated with those balances.
Tracking Credit Card Interest Rate Information
If you are going to carry a balance on your credit card, there are essentially four methods financial institutions and credit card issuers use to calculate and charge interest, they are as follows:
- Average Daily Balance
- Adjusted Balance
- Previous Balance
- Two-Cycle Average Daily Balance
The average daily balance is commonly used and is the sum of the daily outstanding balance(s) divided by the number of days covered in the billing cycle to provide an average daily balance for that period and is then multiplied by a constant factor to determine the interest charge.
- Interest resulting from this calculation is essentially charged at the close of business each day, but it only compounds or gets added to the principle one time per month.
- This particular interest calculation is by far the easiest to compute and understand as it produces a rate that approximates almost, or as nearly to, the equal expected rate.
- The adjusted balance calculation is made by calculating the balance at the end of the billing cycle and is multiplied by a factor to arrive at the interest charge.
- This can result in an actual rate that can be lower or higher than the expected or advertised rate since it does not take into account the average daily balance.
- It does account for money that is lent over the course of several months.
- The previous balance method is similar to the adjusted balance method except your interest will be calculated on the balance(s) collectively accumulated from the previous month.
- You will be paying interest on the current balance minus the amount you paid in the previous month. For the most part, this particular method favors the issuer of the card in that most consumers are still driven to pay only the minimum payment each month.
- The last and probably the most complex way interest calculations can be performed is the two-cycle average daily balance method.
- This particular method is the most expensive way to calculate interest as it considers two months of your average daily balance.
- To make the APR calculation, it takes into account the sum of your average daily balance for the current and previous billing cycles and multiplies that figure by the APR and then divides by twelve.
- Carrying a large average daily balance during the prior billing cycle leads to incurring higher finance charges the following month if you are a consumer who carries over a balance.
Consider the following simplified illustration, a balance of $1500 in the previous billing cycle and $500 in the current billing cycle equates to an average daily balance of $1000 (the sum of the last two months average, divided by 2). Even if you paid off a significant portion of your previous months balance, the two cycle average daily balance would still be calculated at $1000, not the current $500. This effectively doubles the finance charge making it less attractive to carry a higher balance on a credit card that employs this particular method as the preferred interest or APR calculation.
These four interest calculation methods illustrate why it is important to have the credit card interest rate information you need before making your next big credit card purchase. There are more to interest rates than meets the eye and its of paramount importance, especially in tough economic times, to understand what you might be getting yourself into.
