Finance Charges

Introduction

Young adults are always so excited to get their first credit card! Building credit is exciting 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

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 out 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. On your credit card statement, your new balance is determined by the following formula:

New Balance = Previous Balance + Finance Charges + New Purchases - (Payments + Credits)

Example: Gina received the statement shown. Use the information to find her new balance.

New Balance = Previous Balance + Finance Charge + New Purchases - (Payments + Credits)

New Balance = $463.86 + $6.34 + $129.43 – ($50.00 + $31.75)

New Balance = $463.86 + $6.34 + $129.43 - $81.75

New Balance = $599.63 - $81.75

New Balance = $517.88

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!

Summary

Previous Balance Method: The finance charge is determined based on the closing date of your last statement.

Step 1: Finance Charge = Previous Balance x Periodic Rate

Unpaid Balance Method: The finance charge is determined based on the unpaid previous balance.

Step 1: Unpaid Balance = Previous Balance – (Payments + Credits)

Step 2: Finance Charge = Unpaid Balance x Periodic Rate

Average Daily Balance Method: The finance charge is determined based on the average daily balance. To find the average daily balance, take the balance from every day during the billing period, add them together, and divide by the number of days in the billing period.

Step 1: Average Daily Balance = (Balance x Days at that Balance + Balance x Days at that Balance... ) / days in billing period

Step 2: Finance Charge = Average Daily Balance x Periodic Rate

Finance Charges Practice

Read the scenario and determine what the finance charge would be using each of the three methods. You can check your answers by dragging the amounts to the boxes and by clicking the solution boxes.

Using a Spreadsheet Program 📊

Calculating Average Daily Balance in Excel

Excel makes use of a SUM function, which adds up a selection of cells. This is useful for finding the average daily balance. Watch the video to see how this can be done. Then, try it on your own!

Math Connection: The symbol Σ (sigma) is generally used to denote a sum of multiple terms. This is what excel is doing behind the scenes. Typing in =SUM(D2:D5) translates to Σ(10 +10 + 6 + 4) = 30.

IMAGES CREATED BY GAVS