What Is a Finance Charge?

A finance charge definition is the interest you'll pay on a debt, and it's generally used in the context of credit card debt. A finance charge is calculated using your annual percentage rate, or APR, the amount of money you owe, and the time period.

What is a finance charge?

A finance charge is any charge associated with borrowing money and paying it back over time. This includes accrued interest as well as additional fees related to borrowing, such as transaction fees. If you're wondering about the difference between a finance charge vs interest, they're often synonymous in practice, although in some cases, a finance charge can include late fees or other charges.

With credit cards, your finance charge is the interest that has accrued on the money you owe during that particular billing cycle . Most credit card issuers calculate finance charges by applying the annual percentage rate (APR) to your average daily balance.

How your credit card finance charge is calculated

Your credit card finance charge depends on a few factors -- specifically, your annual percentage rate, or APR, the amount of your debt, and the amount of time in the billing cycle.

There are a few possible ways credit card issuers can compute your finance charge, but most work it out on a daily basis using the "average daily balance" method.

• First, your APR is divided by 365 (or 360 in certain cases) to determine your daily rate. For example, a credit card APR of 17.99% would translate to a 0.049% daily interest rate.
• Next, the daily interest rate is multiplied by the number of days in the statement billing cycle to determine your interest rate for each particular finance charge. Continuing the previous example, if there were 30 days in the billing cycle, a 17.99% APR would translate to an interest rate of 1.479% for the billing statement.
• Finally, this rate is multiplied by the amount of debt that is subject to your APR. If you owed $5,000 in our example, you would be assessed a finance charge of $73.95 on your billing statement.

It's also worth mentioning that many of the best credit cards have promotional interest rates (more on that in the next section), as well as different APRs that apply to cash advances. Also, most credit card interest rates are variable, meaning that they can change over time along with a certain benchmark, such as the U.S. Prime Rate.

How to avoid paying finance charges on your credit cards

Other than the obvious route of not charging anything on your credit cards, there are a couple of ways to actually use your credit cards and avoid paying finance charges.

First, if you pay your credit card balance in full every month you won't have to pay any finance charges. You'll need to pay before your credit card's grace period runs out. Most credit cards' grace periods are between 21 and 25 days, and you should be able to easily locate yours on your billing statement.

Alternatively, if you need to carry a credit card balance, there are many cards that offer 0% intro APRs for certain amounts of time. Many offers extend for 12 months or longer, and as I write this, there are 0% intro APR offers for as long as 18 or even 20 months. With competition in the credit card industry at an all-time high, these offers are evolving quite rapidly, so be sure to check out the latest and best 0% intro APR offers. If you have an existing credit card debt that you'd like to avoid finance charges on, look at the 0% intro APR offers specifically geared toward balance transfers.

During the card's promotional period, you won't be assessed any finance charges on qualifying purchases (generally, cash advances don't qualify), even if you carry a balance. Once the promotional 0% intro APR period ends, the balance will start to accrue interest at your standard APR.

Credit card finance charges can be rather high, with the average APR in the neighborhood of 15%. So, if you can avoid finance charges through one of the two methods discussed here, it could certainly be a smart move.

Still have questions?

Here are some other questions we've answered:

• What Is a Penalty APR?
• What Is Deferred Interest?
• How Many Credit Cards Should I Have?