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Nuts and Bolts
Dear Jeff:
I was told there are two ways credit card companies charge interest. One is on the average daily balance and the other is the two cycle average daily balance method. By looking on the back of my statements, I cannot tell which is which. Will you please provide an explanation of the two methods and give me an example to use to see which way interest is being applied to my account.
Jeff Says:
I know the last thing we think of doing when taking out a loan or when obtaining a credit card is reading the specific details of the loan or credit card contained in the agreement. Yet the agreement that you should have received when you applied for your credit card is actually a written contract that sets forth the terms that apply to a credit or charge card account, including the interest rate charged, the method of calculating interest and any annual or transaction fees. This is where I would direct you to answer your question about your credit cards.
You correctly point out that finance charges are usually calculated based on your average daily balance, which is determined by adding the daily balances for the month and then dividing the total divided by the number of days in the billing cycle. Once again, your credit agreement will dictate whether or not new purchases will be included in the calculation.
The second method for calculating finance charges is based on the two-cycle average daily balance. These companies use the balance you owed over a two-month period to calculate your interest. This means they include interest on purchases from the previous statement even if you paid the purchases off immediately. This means that you could pay higher interest charges on credit cards that use the two-cycle average daily balance.
Credit cards are not all the same. Reading the agreement could certainly save you a lot of money even where the interest rates charged are the same.
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