A credit card lets you buy things and pay for them over time. Using a
credit card is a form of borrowing: you have to pay the money back.
When you are choosing a credit card, there are many features — and
several kinds of cards — to consider: Fees, charges, interest rates,
and benefits can vary among credit card issuers. As a result, some
credit cards that look like a great deal at first glance may lose their
appeal once you read the terms and conditions of use and calculate how
the fees could affect your available credit.
Credit Card Terms
application and even in solicitations that don’t require an
application. Here are the most important terms to understand — or ask
about — when you are choosing among credit offers.
Many credit cards charge membership and/or participation fees. Issuers
have a variety of names for these fees, including “annual,”
“activation,” “acceptance,” “participation” and “monthly maintenance”
fees. These fees may appear monthly, periodically, or as one-time
charges, and can range from $6 to $150. What’s more, they can have an
immediate effect on your available credit. For example, a card with a
$250 credit limit and $150 in fees leaves you with $100 in available
Transaction Fees and Other Charges.
Some issuers charge a fee if you use the card to get a cash advance or
make a late payment, or if you exceed your credit limit.
Annual Percentage Rate.
The APR is a measure of the cost of credit, expressed as a yearly rate.
It must be disclosed before your account can be activated, and it must
appear on your account statements.
The card issuer
also must disclose the “periodic rate.” That’s the rate the issuer
applies to your outstanding balance to determine the finance charge for
each billing period.
Some credit card plans let the
issuer change the APR when interest rates or other economic indicators
— called indexes — change. Because the rate change is linked to the
index’s performance and varies, these plans are called “variable rate”
programs. Rate changes also can raise or lower the finance charge on
your account. If you’re considering a variable rate card, the issuer
must tell you that the rate may change and how the rate is determined.
Before your account is activated, you also must be given information
about any limits on how much your rate may change — and how often.
A grace period, also called a “free period,” lets you avoid finance
charges if you pay your balance in full before the date it is due.
Knowing whether a card gives you a grace period is important if you
plan to pay your account in full each month. Without a grace period,
the card issuer may impose a finance charge from the date you use your
card or from the date each transaction is posted to your account.
Balance Computation Method for the Finance Charge.
If you don’t have a grace period — or if you plan to pay for your
purchases over time — it’s important to know how the issuer calculates
your finance charge. Which balance computation method is used can make
a big difference in how much of a finance charge you’ll pay — even if
the APR and your buying patterns stay pretty much the same.
Balance Transfer Offers.
Many credit card companies offer incentives for balance transfers —
moving your debt from one credit card (Card Issuer A) to another (Card
Issuer B). All offers are not the same, and their terms can be
For example, many credit card issuers
offer transfers with low introductory rates. Some issuers also charge
balance transfer fees. If Card Issuer B charges four percent to
transfer $5,000 from Card Issuer A, your fee would be $200. In
addition, if you pay late or fail to pay off your transferred balance
before the introductory period ends, Card Issuer B may raise the
introductory rate and/or charge you interest retroactively. And if you
use your card from Card Issuer B to make new purchases, any payments
you make will go toward your balance with the lowest interest rate —
and finance charges at the higher interest rate will be assessed on the
portion of your balance that came from new purchases.
Balance Computation Methods
How do these methods of calculating finance charges affect the cost of
credit? Suppose your monthly interest rate is 1.5 percent, your APR is
18 percent, and your previous balance is $400. On the 15th day of your
billing cycle, the card issuer receives and posts your payment of $300.
On the 18th day, you make a $50 purchase. Using the:
Average Daily Balance.
This is the most common calculation method. It credits your account
from the day the issuer receives your payment. To figure the balance
due, the issuer totals the beginning balance for each day in the
billing period and subtracts any credits made to your account that day.
While new purchases may or may not be added to the balance, cash
advances typically are included. The resulting daily balances are added
for the billing cycle. Then, the total is divided by the number of days
in the billing period to get the “average daily balance.”
This usually is the most advantageous method for cardholders. The
issuer determines your balance by subtracting payments or credits
received during the current billing period from the balance at the end
of the previous billing period. Purchases made during the billing
period aren’t included.
This method gives you
until the end of the billing period to pay a portion of your balance to
avoid the interest charges on that amount. Some creditors exclude prior
unpaid finance charges from the previous balance.
This is the amount you owed at the end of the previous billing period.
Payments, credits, and purchases made during the current billing period
are not included. Some creditors exclude unpaid finance charges.
Two-cycle or Double-cycle Balances.
Issuers sometimes calculate your balance using your last two month’s
account activity. This approach eliminates the interest-free period if
you go from paying your balance in full each month to paying only a
portion each month of what you owe. For example, if you have no
previous balance, but you fail to pay the entire balance of new
purchases by the payment due date, the issuer will compute the interest
on the original balance that previously had been subject to an
interest-free period. Read your agreement to find out if your issuer
uses this approach and, if so, what specific two-cycle method is used.
- Average Daily Balance method (including new purchases), your finance charge would be $4.05.
- Average Daily Balance method (excluding new purchases), your finance charge would be $3.75.
Daily Balance Double Cycle method (including new purchase and the
previous month’s balance), your finance charge would be $6.53.
- Adjusted Balance method, your finance charge would be $1.50.
If you don’t understand how your balance is calculated, ask your card
issuer. An explanation also must appear on your billing statements.
Other Costs and Features
Credit terms vary among issuers. When considering a credit card, think
about how you plan to use it: If you expect to pay your bills in full
each month, the annual fee and other charges may be more important than
the periodic rate and the APR, and whether there is a grace period for
purchases. If you use the cash advance feature, many cards do not
permit a grace period for the amounts due — even if they have a grace
period for purchases. That makes considering the APR and balance
computation method a good idea. But if you plan to pay for purchases
over time, the APR and the balance computation method definitely are
You’ll also want to consider if
the credit limit is high enough, how widely the card is accepted, and
the plan’s services and features. For example, you may be interested in
“affinity cards” — all-purpose credit cards sponsored by professional
organizations, alumni associations, and some members of the travel
industry. An affinity card issuer often donates a portion of the annual
fees or charges to the sponsoring organization, or qualifies you for
free travel or other bonuses.
Default and Universal Default.
Your credit card agreement explains what may happen if you “default” on
your account. For example, if you are one day late with your payment,
your issuer may be able to take certain actions, including raising the
interest rate on your card. Some issuers’ agreements even state that if
you are in default on any financial account — even one with another
company — those issuers’ will consider you in default for them as well.
This is known as “universal default.”
Special Delinquency Rates.
Some cards with low rates for on-time payments apply a very high APR if
you are late a certain number of times in any specified time period.
This can exceed 20 percent. Information about delinquency rates should
be disclosed in credit card applications and in solicitations that do
not require an application.