What are Finance Charges on Credit Card?

Borrowing a loan or seeking credit in any form; one always tends to compare the interest rates and other fees to ensure maximum savings. So what must one consider to have the best savings? 

People often confuse what is a finance charge, and often interchange it with APR (Annual percentage rate), but there is a difference between both terms. Finance charges are calculated monthly and in rupees while APR is calculated annually and in percentage.       

Definition of Credit Card Finance Charges

A finance charge is a fee amount deducted by your lender to pay on your behalf. Finance charges can be in any form i.e. account maintenance, yearly fees, penalty charges, charges for transactions, alert messages, and more. 

Based on the amount you owe or carry in your credit card, your finance charges differ. Different interest rates are applied for various transactions, and the finance charges are calculated based on the interest rates and the amount pending in those categories. 

The finance charge is the additional amount that you need to pay along with the principal amount. It also includes the primary interest charges. 

Considering finance charges makes you plan effectively, avoid paying more, and plan your finances better. It is necessary to know the components that form the finance charges, and its calculation formula to plan accordingly.

Components of a Credit Card’s Finance Charges

Based on the difference in transactions, credit card companies apply different finance charges to outstanding balances. Some components and factors that affect the calculation and formation of finance charges include:

• Interest Charges

Interest charges consist of more than 80% of the finance charges. It is the amount to pay for the principal amount used. It is applied to outstanding amounts during the billing cycle, and it is influenced by the card's APR. 

• Fees

Finance charges include numerous other fees including annual fees which are fixed amounts charged for using the credit card. Late payment fees, charged for delays in payments, are also a type of finance charge. Delays in payments are also a type of finance charge.

Other examples are cash withdrawal fees and fees for foreign currency transactions.

Factors Affecting Finance Charges  

Different factors affect the finance charges in various manners, and being a credit card holder, you must know and manage such factors.  

• APR: APR rates affect the finance charges. A high APR will result in high finance charges. 

• Credit Card Balance: The more outstanding balance you have on your credit, the higher charges you are levied; as the finance charges are calculated in percentage on the outstanding balance. 

• Payment History: Credit card issuers provide low APR and interest rates to cardholders with good credit histories and high CIBIL scores. Your CIBIL score affects your APR rates, and thus finally affects your finance charges. 

Calculating Finance Charges

To calculate finance charges, calculate the average daily balance and daily APR rate and multiply them by several days in the billing cycle i.e. 28 or 29 days.

The monthly interest rate needs to be paid in addition to the pending amount. To calculate monthly interest rates multiply APR with outstanding balance. 

Illustration

Avg. Daily Balance: Rs.700

APR rate: 17%

Billing Cycle: 30 days 

Daily APR: 17%/365=0.00046 

Finance Charges = (Avg. daily balance X Daily APR X billing cycle)

= 700 X 0.00046 X 30 

= Rs. 9.66

= 700+9.66

= Rs.709.66

How to Avoid Finance Charges?

Since finance charges are a clear loss, one should know how to avoid such costs. You can follow the following practices:

• Always pay your bills on time, and avoid late payments.

• Do not pay your bills in part as the remaining part is calculated for interest.

• Since finance charges formally include APR, you can have a credit card with a low APR to reduce your finance charges. 

• Consider cash withdrawal with a credit card as your last choice, as it is very costly.

• You can consider balance transfers to repay your bills and ensure low interest rates.    

• Choose a credit card with low or no annual fees.

Finance charges are unwanted costs that you can reduce or avoid with proper credit management and monitoring. It is the cost levied on you for using a credit card. Try paying your bills on time, and have low APR credit cards as this is what you can control over the billing cycle and daily average balance.

Consider avoiding services that charge more fees on cash withdrawal or foreign transactions or use for cash equivalent transactions, etc.