If you live in the U.S., chances are you are going to use credit cards throughout your life. You cannot escape it as most of the industries that you interact and transact with today use credit cards, and together with the financial institutions, they have incentivized it as a form of payment. What with all the discounts, rebates and cashbacks that are being offered nowadays. Hence, it’s not enough that you know how to swipe your cards, where to sign a transaction receipt, or how to pay your bills. You need to really understand how credit cards work and how they make money from you, and the only way to do that is to understand the concepts and terms that the credit card industry use. By understanding these terms, you will know the ins and outs of using credit cards, and you’ll be to put things in the right perspective. As we go along, you’ll realize that owning a credit card is no play. It should be taken seriously if you don’t want to learn a financial lesson the hard way.
APR or Annual Percentage Rate
A yearly interest rate that includes fees and costs paid to acquire the loan. Lenders are required by law to disclose the APR. The rate is calculated in a standard way, taking the periodic rate and multiplying it by the number of billing periods in a year. If your credit card says 18% APR, your monthly periodic rate is 18 divided by 12(months), which is equal to 1.5 percent. That percentage is the one used when lenders compute your Average Daily Balance and interest charges.
If you want to know how much you are paying in interest daily, you may use the daily periodic rate which is computed by dividing your APR by 365 days. Using our previous example, an 18% card will have a 0.05% daily periodic rate. As you can see, interest is always expressed in percentage so it’s actual dollar amount goes up as your balance increases as well. Indeed, the sky’s the limit for interest charges!
Average Daily Balance
The method by which most credit cards calculate your payment due, average daily balance is determined by adding each day’s balance and then dividing that total by the number of days in a billing cycle. For instance, you start with a zero ($0) balance on a new card. You charge $800 on a new phone on the first of May and paid only $100 on the 26th, which is then reflected on the next day. This means that for 26 days, you carried a balance of $800, and for 5 days, you carried $700. Your average daily balance is computed like the following example:
[ (26 x $800) + (5 x $700) ] / 31 days = $783
The average daily balance is then multiplied by a card’s monthly periodic rate. Using our above example of 1.5% periodic rate, if your average daily balance is $783, your monthly finance charge would be $11.75, which is automatically added to your new statement. The cycle goes on and that’s how debt multiplies.
Sometimes called the float period, grace period is the “interest-free” time between your billing cut-off and your due date. Usually it’s 20-30 days from your billing cut-off. However, if you are carrying a balance, technically you don’t have a grace period because your average daily balance is being used to compute your new finance charges.
The amount lenders charge you for using your credit card, including interests and other penalty fees. Different cards have different finance charges, so before signing up for a new card, make sure that you have read the fine print which most people ignore. The lower the finance charge (expressed in percentage), the better. However, it’s still best to avoid accruing any finance charges every month.
Some lenders charge fees when your transaction exceeds your available credit limit. This could go as high as $30-$35 per transaction, and these fees are automatically added to your total debt balance. Be careful, especially when you are trying to “de-load” yourself of debt because these little charges can slow down the process.
This is the process of moving your unpaid balances from one lender to another. If you are looking for a way to pay off your debt, be on the lookout for credit card issuers that offer zero balance transfer fees and 0% introductory APRs. Lenders typically have this tactic to entice you to switch to their credit card but that’s a fair exchange to a great APR. Beware, however, because your previous credit card issuer may also charge you with a balance transfer fee when going out. If you get zero fees for both ends of the transaction, then that would be a lot better.
Cash Advance Fee
Do you know that you can get your credit card to actually dispense money? In its physical form? Yes, just like a personal loan from a friend. The difference is that it comes with an expensive cash advance fee. Depending on your credit card issuer, this fee can be in flat rate or a percentage of the amount of the cash advance. If, on your credit card terms and conditions, you see cash advance fees expressed in “3%/$15” it means that the fee will either be 3% of your cash advance or $15, whichever is higher. Your lender always wants the higher amount.
Two-cycle Billing or Double Cycle Billing
Most credit card issuers use only the single-cycle billing when calculating your average daily balance. However, there are ones out there that use the two-cycle billing method, which uses two months to calculate your average daily balance. So, even if you already cleared your debt on the previous month, your creditor using a double cycle billing will still use the previous month’s average daily balance to compute your interest charges. It is still best to avoid carrying a balance but if you can’t help it, at least know that the card you are signing up for does not use a two-cycle billing method.
A lot of us dive into owning a credit card or using it without really bothering to understand how it works, and how it can potentially milk your for years. For new card owners, don’t make the same mistake. Understand the terms and concepts, and read the terms and conditions stated in your credit card’s fine print. As the old saying goes, “look before you leap.”
We hope you did have some “a-ha!” moments while we discussed the above concepts. We hope we were able to enlighten and arm you with knowledge to make better decisions in handling your credit. And if these lessons came in a little too late, you can always start afresh once you finally got out of debt. And of course, if you need help, don’t hesitate to call Financial Rescue. We’ve got 7 years of service on our belt to help you get out debt.