CL - Finance Charges and APR Lesson
Finance Charges and APR
Introduction
Young adults are always so excited to get their first credit card! Building credit is exciting (and yes, sometimes fun) but you will want to make sure you are well aware of all the responsibilities that come along with it.
In short, a bank or credit card company allows you to continuously borrow money up to a certain credit limit. Every time you buy something on credit, that amount is subtracted from your total credit limit. And every time you pay off your balance, your credit limit goes back up.
Although this sounds like a great idea, you have to make sure you are considering the interest. If you don't pay your full credit card balance at the end of the month, the bank will charge you interest on the amount you still owe; commonly anywhere from 10 to 28 percent.
Understanding Account Statements
In Your Notebook: Please take down important notes, such as formulas, and attempt the practice examples on your own before viewing the solutions!
If you are going to use a credit card, it is very important to understand how to read an account statement. In order to figure your charges for the month, the credit card company picks a day to close the month - the closing date. This date is not always the last day of the month. If you do not pay the minimum payment on time, a finance charge is added. If you do not pay the minimum payment in full, a finance charge is added. If your balance goes over the credit limit, a finance charge is added. See a pattern? In addition, if any of these things happen you commonly lose any low interest rate promotions and they can raise your interest rate as well. Let’s take a look at an account statement.
Finance Charges
The following are three common methods credit card companies use when determining finance charges. Click each tab to learn more!
In Your Notebook: Please take down important notes, such as formulas, and attempt the practice examples on your own before viewing the solutions!
APR – Annual Percentage Rate
Credit cards usually use their APR as a selling point for new customers. But, what is an APR?
This is an interest rate that is applied to the credit card balance each period. The period could be each month, quarterly, etc. The APR, or annual percentage rate, can be found my adding up all of the periodic rates, or if the rate remains the same throughout the year, you can multiply the rate by the number of periods.
APR = Periodic Rate x Number of Periods in a Year
Periodic Rate = APR / number of periods
Example 1: What is the APR of a credit card that has a daily periodic rate of 0.06%?
APR = Periodic Rate x Number of Periods in a Year
APR = 0.06 x 365
APR = 21.9%
Example 2: What is the monthly periodic interest rate for a credit card with an APR of 22.4%?
Periodic Rate = APR / number of periods
Periodic Rate = 22.4 / 12
Periodic Rate = 1.9%
Credit Card Comparisons
Sometimes, credit card companies make their fees hard to find. Look up three different credit cards and fill out the following chart. Which credit card seems like the best option?
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