Introduction
When it comes to calculating finance charges on credit cards, different methods can be employed by card issuers. These methods can have varying implications for both the cardholder and the issuer. In this article, we will explore the different methods used to calculate finance charges and analyze which method is most favorable to the card issuer.
Average Daily Balance Method
One commonly used method to calculate finance charges is the average daily balance method. This method takes into account the balance on the card at the end of each day over the billing cycle. The sum of these daily balances is then divided by the number of days in the billing cycle to determine the average daily balance.
Advantages for the Card Issuer: The average daily balance method tends to favor the card issuer as it includes the entire billing cycle in the calculation. This means that even if the cardholder pays off a significant portion of their balance during the billing cycle, the issuer can still charge interest on the remaining balance for the entire cycle.
Two-Cycle Average Daily Balance Method
The two-cycle average daily balance method is another approach used by card issuers to calculate finance charges. This method considers the average daily balance over two billing cycles instead of just one.
Advantages for the Card Issuer: The two-cycle average daily balance method can be more favorable to the card issuer than the average daily balance method. It allows the issuer to charge interest based on the cardholder’s average daily balance over two billing cycles, even if the balance was paid off in full during the previous cycle. This means that if the cardholder carries a balance from one cycle to the next, the issuer can continue to charge interest on that balance.
Adjusted Balance Method
The adjusted balance method is yet another way to calculate finance charges. This method considers the balance at the beginning of the billing cycle and subtracts any payments or credits made during the cycle. The resulting balance is then used to calculate the finance charges.
Advantages for the Card Issuer: The adjusted balance method can be advantageous for the card issuer as it only takes into account the balance after payments or credits have been applied. This means that if the cardholder makes a payment during the billing cycle, the issuer can calculate the finance charges based on the remaining balance, allowing them to charge interest on a higher amount.
Conclusion
In conclusion, the methods used to calculate finance charges on credit cards can have varying implications for the card issuer. While all methods allow the issuer to charge interest, the average daily balance method and the two-cycle average daily balance method tend to be more favorable to the issuer as they consider the balance over a longer period of time. The adjusted balance method, on the other hand, can also be advantageous for the issuer as it allows them to charge interest on a higher balance after payments or credits have been applied.
References
– Bankrate: www.bankrate.com/credit-cards/how-credit-card-interest-calculated/
– Investopedia: www.investopedia.com/terms/f/finance-charge.asp
