ON THE MONEY: How credit card companies calculate interest
Credit card companies make hundreds of millions of dollars on the interest that they charge card users.
The simplest way to avoid interest and other charges is to pay off your entire balance each month within the time frame (grace period) stated on your bill, which must be at least 21 days in length.
But if you don't pay the card's balance in full each month, to calculate how much your interest charge will be for that month, you will first need to calculate your average daily balance.
Assume that in a 30-day period, you have a $5,000 balance carried over from the previous month, and you made a $500 purchase on the 15th of the new month, and on the 20th day you made a payment of $1,000.
For the first 15 days, your balance was $5,000; for the next five days, your balance was $5,500, and for the last 10 days your balance was $4,500.
Your average daily balance is in reality as weighted average balance, so then, $5,000 times 15 equals $75,000, $5,500 times 5 equals $27,500, and $4,500 times 10 equals $45,000.
Your average daily balance was $147,500 divided by the 30 days in the month equals $4,917.
Next, we have to calculate your daily interest rate, since almost every card calculates its interest this way.
If your card has an annual percentage rate of 11 percent, we will divide that rate by the 365 days in a year, or .11/365 equals 0.000301, and this is the card's periodic interest rate.
If we multiply $4,917 by 0.003, we arrive at the interest charge for this month of $147.50
One of the provisions of the Credit Card Act of 200 deals with the situation in which a credit card company is going to raise your annual percentage rate or any other fees and charges.
Your credit card company must send you a notice 45 days before they can increase your interest rate; change certain fees (such as annual fees, cash advance fees, and late fees) that apply to your account; or make other significant changes to the terms of your card.
Moreover, this legislation prevents your credit card company from increasing your rate for the first 12 months after you open an account, with a few exceptions, such as a variable rate.
If you have an introductory rate, it must stay in place for at least six months.
If the card company does increase its interest rate, that new rate must only apply to purchases made after the date of the increase.
There are two additional points to bear in mind. First the interest that you are charged is from the date of purchase, not from the beginning of the next month.
There is no grace period unless you pay off your balance in full at the end of the period, in which case the interest charges are waived.
Secondly, the Credit Card Act of 2009 stipulated that credit card statements include a section that clearly outlines how long it will take you to pay off your card if you only pay the minimum balance.
If you make a habit of only paying the minimum each month, it would benefit you to pay attention to that section and make plans to pay off your balance as quickly as possible.
Many credit cards provide credit protection and extended warranties, and you can find this information in the credit card's disclosure statement.
Benefits such as these are extremely valuable if your merchandise gets stolen or damaged in shipment, so it will pay you to find out if your card offers such benefits.
If your card offers a rewards program, make certain you have read all the fine print.
More than a few of these reward cards offer nothing but dog meat, and even discovering the truth about the program can be difficult.
You might try Googling your card to discover what information you can glean from the Internet about this particular rewards card.
It will always pay you to relentlessly check your credit card statements each month for possible errors and fraud.
If you do uncover a billing error, the Fair Credit Billing Act affords you protection.
You should write your card issuer within 60 days of the date the statement containing the error was prepared.
The new law requires the issuer to respond within 30 days and to conduct a subsequent investigation within 90 days. You may go to www.in.gov/dfi/2590.htm to read a summary of the law's provisions.
Greg Roberts is a certified financial planner with 35 years of financial and estate planning experience. Got a financial planning question for Greg? You may email him at firstname.lastname@example.org.