Credit Card Basics

This page explains basic credit card terms that everyone should be familiar with.

Annual Percentage Rate - The APR is the interest rate that you will be charged on your purchases, balance transfers or any cash advance. It is expressed as an annual rate. The interest rate that you will be charged monthly is calculated by taking the APR divided by 12. So for example, if the APR for purchases is 15%, then your monthly or periodic rate will be 15% divided by 12 which is equal to 1.25%.

The Annual Percentage Rate of a credit card can either be fixed or variable. Most are variable which means that they are indexed to the particular interest rate. Most of the time, APR are indexed to the Prime Rate. They can also be indexed to LIBOR, which is the London Interbank Borrowing Overnight Rate. Banks have to state the margin over the index under the terms and conditions of the credit card that they are offering.

Grace period - The Grace Period is the period (usually 20 to 25 days) which lets you avoid finance charges by paying your balance in full before the due payment date. The credit card issuer must mail your bill at least 14 days before the due date to allow you enough time to pay your bills. If there is no grace period, you will incur finance charges from the date of each purchase you make on your credit card. Most credit card allow a 20 to 25 grace period for purchases but there are normally no grace periods for cash advance.

Balance Calculation Method - There are several methods for computing your balance. The methods will affect your finance (interest) charges every month.

Average Daily Balance Method - This is the most common method. There actually 2 variations to this method. The first being Average Daily Balance excluding new purhcases and the other is the Average Daily Balance including new purchases. The monthly balance is derived by taking the balance and subtracting any payments or credits received each day during the entire billing period. The total is then divided by 30 days. If the calculation method includes new purchases, the new purchases will be added to the balance and will be excluded if it is not included in the calculations. The Average Daily Balance Method excluding new purchase will result in a lower balance than the Average Daily Balance method including new purchases. (See examples of balance calculation methods)

Adjusted Balance Method - This is the method most credit card holders will prefer. The balance is calculated by taking the balance and subtracting any payments or credits made each day for the whole billing period. That means you have unitl the end of the billing cycle to pay off a portion of your balance and avoid finance (interest) charges on that portion. New purchases made during the billing cycle are not included in this method of calculation.

Previous Balance - This method of calculating your balance simply takes the previous month's balance. Any payments, credits or new purhase during the current billing cycle is not included.

2-cycle Average Daily Balance - Some issuers will calculate your balance using 2-cycles rather than just the current billing cycle. This may result in a higher balance especially if you had a higher than normal balance the previous month and a lower balance during the current month.

Example of Various Balance Calculation Method
Average Daily

New Purchases)
Average Daily

New Purchases)
APR 15% 15% 15% 15%
Monthly Rate
APR divided by 12
1.25% 1.25% 1.25% 1.25%
Previous Balance $500 $500 $500 $500
New Purchase $100 on 20th day $100 on 20th day $100 on 20th day $100 on 20th day
Payments $200 on 15th day $200 on 15th day $200 on 15th day $200 on 15th day
Balance ($500x 15 days) plus
($300 x 15 days)
($500x 15 days) plus
($300 x 5 days) plus
($400 x 10 days)
Finance Charges (1.25% x $400)
(1.25% x $433)
(1.25% x $200)
(1.25% x $500)

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