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August 27, 2006
How Your Interest Charge Is Calculated
You almost need to be a mathematics major to understand how the credit card companies arrive at the figure that shows up on your monthly statement under the heading Interest Charge. Come to think about it, forget the "almost." You do need to hold a mathematics degree.
Not only is the formula complex, but it is not standardized. Different cards use different techniques, and if you are concerned about the amount of inter¬est you pay, you need to understand how they work. Of course, it's all in the small print in your cardholder agreement, but who takes the time to read through all that? So here's a quick summary of the different calculation tech¬niques that are used. Ask your credit card customer service desk to tell you which one they apply. Remember, if you pay off your full balance owing each month, none of this need concern you.
Average daily balance
Here the company simply calculates the average daily amount of your out¬standing balance over the current billing cycle and applies to that figure the annual rate divided by 12. If your average daily balance is $1,000 and your annual interest rate is 12 percent, your interest charge for that month is $10 (1 percent of $1,000). The advantage of this method is that you are credited for any payments made during the latest period.
Prior month's balance
With your previous month balance you will pay interest for the entire billing period on the balance that you owed at the end of the previous month. You get no credit for any payments made since then, even if you paid off the entire debt in full!
Adjusted prior month's balance
This is a variation on the prior month's balance calculation, but it works in your favor. Here you are credited with any payments made during the present billing cycle before your interest owing is calculated.
Watch for the term “Two-Cycle”
That's our name for it, but the tip-off that you're facing it is the term "two-cycle" in the cardholder literature. Avoid this at all costs. It's a combination of the prior month's balance and the average daily balance that works in such a way as to maximize your interest expense.
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