I’ll start this off by confessing to something that most fall prey to but never really admit: going all in for that 0% introductory interest rate.
It’s all fun and games until the introductory rate expires, and what follows is a horror story of interest rates that suck in all your hard-earned money and leave you barely able to pay off the minimum each month. It happens.
Having a credit card has so many enticing benefits that we often forget the strings attached.
Today I will give you the most practical tips to keep your credit card interest rates on a minimum. But first, here’s a quick introduction on what finance charges are.
What is a finance charge?
A finance charge is basically a fee that you have to pay for extending any existing credit. This applies to most transactions involving commoditized credit services like car loans, mortgages and credit cards.
The most common finance charge you might have heard of is the interest rate, which, as most lenders will explain to you, depends on your credit scores and history, and the type of financing you want.
The difference with the types of finance charges is whether they come from secured financing backed by an asset like a mortgage or a vehicle, or from unsecured financing like credit cards. We’ll talk about credit cards in a bit.
Finance charges are separate from any other fees you have to pay for obtaining a credit service, such as annual fees or late fees, even. Finance charges might include:Interest fees
- Membership fees
- Service fees
- Transaction fees
- Loan fees
- Appraisal fees
- One-time fees like origination fees
Here’s a helpful trick to help you remember all the additional fees you find yourself paying every billing period: finance charges are fees you wouldn’t have to pay if you made the transactions in cash instead of credit.
Types of finance charges
1. Personal Loans
Finance charges on personal loans are inclusive of all fees: interest fees and additional ones that the lender requires before you take out the loan.
2. Auto Loans
Finance charges include all the costs you have to pay according to your lender’s terms, such as application fees and interest fees.
Your total cost of credit on mortgages is also known as its finance charges. This is because the total amount of interest is added to loan charges like private mortgage insurance, document preparation fees, origination fees, etc.
4. Credit card finance charges
Credit card companies make sure that you pay off your balance and finance charges in full before you get a new grace period for your next billing cycle.
Otherwise, starting a new billing cycle with a balance from the previous one will make you susceptible to increased finance charges on every purchase you make with your card.
Finance charges on credit cards
Simply put, technical terms aside, a finance charge is the fee you pay if you took your time paying off your credit card balance.
Paying your balance usually has a grace period, and once you go beyond that period, your issuer will start putting fees depending on how long you’ve been putting it off.
Credit card companies have a legal requirement to bring you your monthly credit card billing statement in 20 to 25 days. These statements are usually just two to three pages in length, detailing the amount you have to pay this month, the payments you’ve paid and didn’t pay from last month, and the deadline you’re supposed to pay your balance off and avoid getting a penalty– or a finance charge.
Issuers are also required to disclose your minimum payment and how long it will take you to pay off your balance based on it.
Credit card finance charges have different types as well:
- Purchase annual percentage rate: interest rate charged on your purchases if you don’t pay off your balance in full and in time during the grace period.
- Balance transfer annual percentage rate: interest rates charged on balances when you move it from one card to another. This is the balance that introductory promotional rates often apply to.
- Cash advance annual percentage rate: these transactions don’t have a grace period, so interest begins as soon as the transaction begins.
Head on over to this video if you need more help understanding credit card interest rates:
How are finance charges calculated?
Finance charges aren’t flat-fees: they change every now and then because they’re calculated based on your balance and any of your credit card company’s interest rates. The general idea is that the higher those two are, the higher your finance charges will be.
Try looking back at any previous billing statements and figure out how your issuer calculates your charges. Believe it or not, estimating your own finance charges can actually help you plan ahead and minimize finance charges on your next billing statements.
Here are five ways your finance charges are being calculated:
1. Daily Balance
The daily balance method uses the balance each day of your billing cycle and multiplies this with the daily interest rate. This produces a daily finance charge that will be totalled for the finance charge for the specific billing cycle.
2. Average Daily Balance
The average daily balance uses the same method as the daily balance, except the daily balance is totalled and divided by the number of days your billing cycle has. This method is the easiest way to calculate finance charges and actually cut back some finance charges by paying off your balance earlier.
3. Ending Balance
This method takes the balance left over from the previous billing cycle, subtracts the payments and adds the charges made during the current cycle. The number of days no longer has an impact when your issuer uses this way to calculate finance charges.
4. Adjusted Balance
The adjusted balance method takes the balance at the beginning of the billing cycle (meaning unpaid charges from the previous cycle) and takes off subsequent payments you’ve made during the cycle.
Not a lot of credit card issuers use this method, and what do you know? This method practically guarantees the lowest finance charges.
5. Previous Balance
This method is fairly simple: all you have to do is pay the balance at the beginning of your billing cycle, which you’ll know is the one carried over from the ending balance of your last billing cycle.
Finance charges FAQ’s
When do I get charged?
Depending on your billing cycle, your credit card issuer will send a bill of charges every month or less (the legal requirement is 21 days). The finance charges are usually calculated on the last day of your billing cycle, gathered from all your spending activity.
So when do financial charges usually appear? These four situations are the most common:
- You haven’t fully paid off your balance from the previous billing cycle. This gets transferred as an additional fee at the beginning of the new cycle.
- Your credit card issuer doesn’t offer a 0% interest annual percentage rate.
- The transactions don’t have a grace period, in cases such as cash advances.
How much will I be charged?
Finance charges are calculated based on your interest rate and credit card balance, so it varies every month if there are any.
Credit card issuers usually calculate by taking the average of your daily balance, as well as any remaining balance from previous billing cycles.
Where can I see my finance charges
Take time to learn what all the terms and numbers on your monthly credit card billing statements mean.
The finance charge is sometimes called the “interest charge”, which you’ll see right on the first page, as part of your account summary that lists your balance, credits and purchases.
The breakdown section indicates where your finance charges are the date that it was assessed. Usually, you’ll see a breakdown of the finance charge itself, identified by the type of balance and its details because different types of balance have their own interest rates and grace periods.
Are my finance charges being regulated?
There are legal requirements imposed on credit card issuers to prevent any predatory lending practices.
The Truth in Lending Act requires that all interest fees, penalty fees and standard annual fees must be disclosed to the client, which you can see broken down in your credit card billing statement.
The Credit Accountability and Disclosure Act of 2009 also ensures you the 21-day grace period before interest rates and finance charges can be assessed
Get yourself acquainted with the history of the credit card and how lending regulations have developed over time https://www.youtube.com/watch?v=7ytdh6fxLOk
How to reduce and avoid finance charges
Obviously, the answer here is not to miss the point of getting a credit card and avoid making any charges on it whatsoever. That’s just bad financial advice!
There are ways you can use your credit card and still avoid any finance charges. There are, however, some finance charges on balances that you can’t avoid.
Balance transfers and cash advances typically don’t have any grace period, especially if you made these transactions without a promotional or introductory rate. The simplest way to avoid these is to refrain from making these transactions completely.
That said, here’s what you can do to substantially reduce the finance charges on your next billing cycle.
How to pay off finance charges
The minimum credit card payment is printed on the first page of your monthly credit card billing statement.
Paying that off should be enough to cover the finance charge by itself, and possibly a small amount of the monthly balance. That’s not the smartest move, though: if you think about it, the money that should’ve been spent on paying your balance went to interest, and might potentially lead to another round of finance charges for the next month, which is really not what you want!
To pay your balance off faster, you’ll need to drastically increase your monthly minimum payment.
How to reduce finance charges
Credit card interest rates can be ruthless. Most of the time it leaves even the best of us not knowing what to do, because we end up only being able to pay the minimum payment each month, which means the interest rates will be higher the next.
It’s a good thing there are ways to break out of the vicious cycle and minimize the debt:
1. Pay your balance in full and in time.
Here’s what you need to know: interest rates are subject to a number of variables, and most of these are things you can actually control. Always pay your balance in full and in time.
Only paying a part of your balance can actually increase your finance charges for the next cycle: whatever method your issuer uses to calculate the finance charges, having a large unpaid balance will go on top of interest rates and make you pay more.
It may be hard, but building this as a consistent practice will pay off in the long run: pretty soon you’ll find yourself patting your back every time you get your credit card statement instead of panicking about what you’re going to do about the interest rates.
Paying on time pays off because the thing is that even with a promotion for low-interest rate or 0% interest rate, you can actually prematurely lose this if you’re behind on your payments for 60 days.
You’ll get a high penalty rate on your balance for six months in a row, and even if you’re caught up with all the payments, you won’t get the promotional rate back. So be smart and always make sure you’re paying off your balance on time.
2. Lower your interest rates
Don’t go rushing to create a new card with a lower interest rate just yet. Besides, depending on the balance your current credit card has, an inquiry into your history can reveal your credit score and result in even higher interest rates.
One thing you can try is requesting or negotiating a lower interest rate. Here’s how you can do it:
- Try asking around and doing your research. Specifically look for credit card companies that offer lower interest rates. This is good leverage during your negotiation: the company will want to keep you as a client(especially if you’ve been a member for a long time– loyalty pays!) and have a higher possibility of arriving at a compromise regarding your interest rates.
- Start simple: use the customer service number. Build a frequency of calls throughout let’s say a few months. Persistence is key– keep trying and don’t stop until you’re connected to a manager or a representative.
- Build a script that you can follow.
3. Move your balance to a credit card with a lower interest rate
Sometimes the first way doesn’t work out. If it doesn’t, then you can now consider transferring your balance to a credit card with lower interest rates, or at least a low introductory rate that you can pay off.
Use the information you’ve gathered about other credit card companies and interest rates. Look for the best transfer deals, too.
Here’s a few tips to keep you afloat:
- Don’t attempt to transfer your balance to another credit card that’s from the same company. You won’t get any benefits or introductory promotional rates.
- Compare and contrast the introductory rates of competing companies and check out the best 0% introductory rates. The common rate is 12 months minimum. Some have offers as long as 21 months.
- Make sure not to repeat any previous mistakes and be sharp about balance transfer fees, annual fees, and any other strings attached.
- If the new credit card comes with a low introductory rate, be quick to pay off your entire balance before it expires. Chances are when the promo rate expires, you’ll get transferred to a high-interest rate balance.
4. Limit credit card transactions to one type during the promotional rates.
If you’ve succeeded in getting a new credit card with the best introductory interest rates, good for you. The promo rate, however, often applies to just one type of credit card transaction, so the best move here is to limit your transactions to only that kind until it expires.
You’ll see that your payments are actually going to the balance with the best interest rate.
5. Don’t max out your credit limit.
Try limiting yourself to 35% and below of your credit limit, because exceeding it will make a blow to your credit scores and increase interest rates.
It also helps to check out your credit scores now and then to keep track of your financial activity.
Check out this video for more tips on avoiding credit card finance charges: https://www.youtube.com/watch?v=x2-0MdZtQ_I
The biggest lesson you’ve learned here today is to always pay your bill on time and in full. Lending practices can get pretty complicated and it’s easy to get lost in the different fees and interest rates put on top of your balance.
Rather than working around the knots, your life can be so much easier if you do your research and follow the rules.
If you’ve learned more than a thing or two from this post, share it to your friends and start making smarter decisions together.
Any stories you’d like to share about credit card finance charges and the lessons you’ve learned? I’m sure everyone would appreciate them in the comments!
Like this post? Read about my tips for different kinds of insurance here: