DEFINITION of ‘Total Finance Charge’
The amount of money a consumer pays for borrowing money on a credit card. The finance charge is a fee that applies when you carry a balance on your credit card past the due date. The finance charge is based on your interest rate for the types of transactions you’re carrying a balance on — purchases, balance transfers and cash advances, each of which might have a different interest rate— and the amount you owe in each of those categories. Your total finance charge gets added to all the purchases you make and the grand total, plus any fees, is your monthly credit card bill
BREAKING DOWN ‘Total Finance Charge’
Credit card companies calculate finance charges in different ways that many consumers may find confusing. A common method is the average daily balance method, which is calculated as (average daily balance × annual percentage rate × number of days in billing cycle) ÷ 365.
The hardest thing to figure out is what your average daily balance was during the billing cycle. To calculate your average daily balance, you need to look at your credit card statement and see what your balance was at the end of each day. (If your credit card statement doesn’t show what your balance was at the end of each day, you’ll have to calculate those amounts as well.) Add these numbers, then divide by the number of days in your billing cycle.
To provide an oversimplified example, suppose your daily balances were as follows in a five-day billing cycle, and all your transactions are purchases:
Day 1: $1,000
Day 2: $1,050
Day 3: $1,100
Day 4: $1,125
Day 5: $1,200
Divide this total by 5 to get your average daily balance of $1,095.
The next step in calculating your total finance charge is to check your credit card statement for your interest rate on purchases. Let’s say your purchase APR is 19.99%, which we’ll round to 20% (or 0.20) for simplicity’s sake. Now you have all the inputs you need to do the calculation.
($1,095 × 0.20 × 5) ÷ 365 = $3 = Total finance charge
Your total finance charge to borrow an average of $1,095 for 5 days is $3. That doesn’t sound so bad, but if you carried a similar balance for the entire year, you’d pay about $219 in interest (20% of $1,095). That’s a high cost to borrow a small amount of money.
On your credit card statement, the total finance charge may be listed as “interest charge” or “finance charge.” You can completely avoid paying a finance charge if you pay your credit card bill in full and on time.