Most of the credit card companies make the bulk of their money from finance charges. A finance fee comprises of the extra charges that are added on to your existing balance if it isn’t paid off in full within the grace period, or before the next billing cycle.
The charges can vary depending on your balance and the APR of your credit card. Although they may seem small if you’ve got low balance of around a few hundred dollars, they can certainly add up and form a big amount if the unpaid balance is huge.
It is also possible that you won’t be doing much more than paying the interest on your credit card, if you only make the minimum payment each month, while leaving the principal balance untouched.
And the worst thing is that the less you pay each month on an existing balance, the more you will pay have to pay in interest, year after year. This may become a never ending cycle as you will be paying the interest only each month and the original amount borrowed will remain the same.
How to Avoid Paying Finance Charges
The best way to avoid paying finance charges is by contacting your bank and asking them exactly how they calculate the finance charges, and when they apply them to your balance.
How do Banks Calculate Finance Charges?
Different banks use different methods, so it’s important to talk to them directly in order to get the right information.
The average daily balance method
The average daily balance method is one of the methods used by banks, whereby they take your daily balance, divide it by the days in the month and then multiply it by the credit card APR divided by 12 months.
For example, suppose that your APR is 20% and your average daily balance is $500, this will make your finance charge around $8.33 a month, or nearly $100 a year. And this amount does not include the compounding interest.
Two-Cycle Billing Period
Another method for calculating the finance charges is the two-cycle billing period. This method takes the sum of the last two months to determine the applicable finance charges. But most of the banks that use this method leave out new purchases, so the finance charge is similar to the average daily balance system.
Finance charges increase the initial borrowed amount to a great extent. Thus, the best practice, aside from understanding how your bank assesses finance charges, is to avoid paying them.
Conclusion
In order to avoid the finance charges, try a credit card balance transfer to a 0% APR credit card, if you have a large balance at a high APR. This way, you will only have to payback the principle amount and avoid paying the finance charges for up to 12 months. You may even be able to pay the credit card off completely without having to pay any finance charges or associated fees.
It is better not to make the minimum payments on your credit cards unless there is no other option left for you. Paying only the minimum will result in the highest amount of finance charges, and a life full of debt.
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