Your credit card or loan billing statement will always contain your finance charge, so there’s not necessarily a need to calculate it on your own. But, knowing how to do the calculation yourself can come in handy if you want to know what finance charge to expect on a certain credit card balance. You can calculate finance charges as long as you know three numbers: the credit card (or loan) balance, the APR, and the length of the billing cycle.
Calculating Finance Charges the Simple Way
The simplest way to calculate a finance charge is to multiply the credit card balance by the periodic interest rate - which is the interest rate broken down to a specific time period. For this example, we’ll say each billing cycle lasts a month, so there are 12 in the year. You have a $500 credit card balance and the APR is 18%. The finance charge calculation is balance X periodic rate. First, calculate the periodic rate by dividing the APR by the number of billing cycles in the year, which is 12 in our example. Remember to convert percentages to a decimal. The periodic rate is .18 / 12 = 0.015 or 1.5%. The monthly finance charge is 500 X .015 = $7.50.
Calculating Finance Charges With Shorter Billing Cycles
With most credit cards, the billing cycle is shorter than a month, which means there are more than 12 billing cycles in the year. You can calculate the number of billing cycles in the year by diving 365 by the number of days in each billing cycle. If your billing cycle is 25 days long, there are 14.6 billing cycles (365 / 25). This makes a difference in the periodic rate, which is APR / # billing cycles or in our example .18 / 14.6 = .012 or 1.2%. The finance charge for that billing period would be 500 x .012 = $6.16. The finance charge is lower than the first example because you’re paying interest for fewer days. It all evens out by the end of the year.
Variations in Credit Card Issuer Finance Charge Calculation Methods
The examples we’ve done so far are simple ways to calculate your finance charge, but still may not represent the finance charge you see on your billing statement. That’s because your creditor will use one of five finance charge calculation methods that takes into account transactions made on your credit card in the current or previous billing cycle. Read the back of your credit card statement to figure out which method your credit card issuer uses.
The ending balance and previous balance methods are easier to calculate. The finance charge is calculated based on the balance at end or beginning of the billing cycle.
The adjusted balance method is slightly more complicated; it takes the balance at the beginning of the billing cycle and subtracts payments you made during the cycle.
The daily balance method sums your finance charge for each day of the month. To do this calculation yourself, you need to know your exact credit card balance everyday of the billing cycle. Then, multiply each day’s balance by the daily rate (APR/365). Add up each day’s finance charge to get the monthly finance charge.
Credit card issuers most often use the average daily balance method, which is similar to the daily balance method. The difference is that each day’s balance is averaged first and then the finance charge is calculated on that average. To do the calculation yourself, you need to know your credit card balance every day of the month. Add up each day’s balance and then divide by the number of days in the billing cycle. Then, multiply that number by the periodic rate.
