Your Credit Card & the Interest Charges – Do You Really Understand the Interest Calculations?

Credit Card have become the convenient way of shopping for the products and services in the civilized world. Banks continuously bombard the consumer with the messages of the benefits of using their credit card.

It is true that there are benefits, most obvious is that your credit card company will not charge any interest on your purchase if you make a full payment of the entire outstanding balance every month.. That means that your own money can keep on accumulating interest in your favour in your bank for that duration.

Credit card companies, however, do charge interest if the outstanding balance is not paid in full every month. The interest rate is stated in their card holder’s agreement. The fact is that the card issuers count on those consumers who do not pay their outstanding balances in full for the viability of their credit card operation.

Though interest free period is well known to the consumer, most do not know how the interest is calculated if the balance is not paid in full. To understand let us get familiar with the following terminology:

APR= Annual Percentage Rate

ADB= Average Daily Balance

NDR= Total Number Of Days Revolved Before Payment Is Made

RRFC= Residual Retail Finance Charge… interest charged back to the original time of the transaction and up to the time if a payment is not made in full.

Let us say, if one makes a purchase of 500 dollars and pays $490 dollars when the statement comes. As the payment is not made in full, the credit card company will charge interest on the full amount of $500 dollars from the date of the purchase. Most common method of interest calculation, by the card issuers is as follows:

(APR/100 x ADB/365) x NDR

When the card holder gets a monthly statement, the interest is calculated till the statement date and that is included in the statement.

For example, take the following case of a credit card:

Date of Purchase Made: Feb. 20, 2010

Statement Date: April 2, 2010

Outstanding amount Including Interest accumulated till the statement date: $1,513.00

Payment Due Date: April 22, 2010

If the card holder sends in the payment of $1,513.00 to the credit card company on the due date, he will still see a small portion of the interest that is accumulated from the credit card statement date to the date the all outstanding amount is paid in full,

(Total amount accumulated from Date of Purchase Feb. 20, 2010 to April 22, 2010 Less Total amount accumulated from Date of Purchase Feb. 20, 2010 to April 2, 2010 )

This is because of the RRFC (Residual Retail Finance Charge… interest charged back to the original time of the transaction and up to the time if a payment is not made in full).

Though millions use the credit cards daily, few read the card holder agreements, and fewer are aware how the interest is calculated on their outstanding balances. If the consumer was to become more aware of this, perhaps many will try to pay more than the minimum payment required.

Governments are stepping in now to make the card holder agreements in plain English and more transparent that are easier to understand. Banks are not really worried, at least not as yet, as the consumer’s attitude remains nonchalant.

Author: Nawel K Seth, M.A.Sc; MBA

The author, Nawel K Seth is a veteran in the field of

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