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Understanding Credit Card Finance Charges: Calculation Methods and Examples

This section explains how finance charges on credit cards are calculated based on your Annual Percentage Rate (APR). It covers the use of monthly or daily periodic rates derived from the APR, providing formulas to calculate finance charges. The text details two primary methods for determining the balance subject to these charges: the previous balance method and the adjusted balance method. Each method is explained with examples, enhancing your understanding of how payments, credits, and new purchases affect your credit card balance.

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Understanding Credit Card Finance Charges: Calculation Methods and Examples

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  1. Chapter 4, Section 2 Credit Card Finance Charges

  2. How are finance charges calculated? • They are calculated based on your APR and using a monthly or daily periodic rate. • To find the periodic rate, divide the APR by 12 or by 365 and round to the nearest ten-thousandth (4th spot after the decimal).

  3. Formula for Finance Charge • Balance subject to finance charge x periodic rate x number of periods • Example 1 • Check Your Understanding A & B

  4. How do credit cards figure the balance subject to finance charges? • The balance can be found by several methods—previous balance method, OR adjusted balance method.

  5. So how does the “previous balance method” work? • It charges interest on the balance in the account on the last billing date of the previous month. • Any payments, credits, or new purchases in the current month are NOT INCLUDED in the previous balance. • New balance= (finance charge + new purchases + fees) – (payments/credits) • Example 2 • Check your understanding C & D

  6. How does the “adjusted balance method”? • This method subtracts payments and credits during this month from the balance at the end of the previous month. • Purchases and fees made during the current month are not included in the adjusted balance. • Adjusted balance = previous balance – (payments + credits) • New Balance = adjusted balance + finance charge + new purchases + fees • Example 3 • Check your understanding E & F

  7. Let’s Practice! • P. 141-142, 5-16

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