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Tata Capital > Blog > Generic > What are Finance Charges in Credit Cards?

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What are Finance Charges in Credit Cards?

What are Finance Charges in Credit Cards?

In the ever-evolving financial world, credit cards are a popular instrument of convenience, offering users the ability to make purchases instantly and pay for them at a later date. Despite their widespread usage, many consumers remain perplexed about certain credit card terms. Among these, one phrase that consistently generates confusion is "Finance Charges." So, what are the finance charges on credit cards? Understanding finance charges in credit cards is crucial for responsible financial management. Let us delve deeper to demystify this commonly used, yet frequently misunderstood term.

What are Finance Charges?

Finance charges, in a nutshell, are the costs you incur for borrowing money through your credit card. These charges come into play when you carry a balance past the due date, take out a cash advance or execute a balance transfer. Understanding these charges is critical because they can significantly impact your credit card bill and overall financial health.

How are Finance Charges Calculated?

To comprehend how finance charges are calculated, it is important to first understand the various components involved. The calculation typically involves your annual percentage rate (APR), the type of balance you have, your balance amount and the length of time it is carried.

Primarily, your APR, which is your yearly interest rate, is used in the calculation. This rate is divided by 365 (days in a year) to get the daily periodic rate (DPR). The DPR is then applied to the different types of balances (purchases, cash advances or balance transfers) you might carry on your card.

The average daily balance method is a common approach utilised by many credit card issuers. With this method, the issuer calculates your balance each day for the billing cycle, adds these together and then divides by the number of days in the cycle. The resulting figure is multiplied by the DPR, and then again by the number of days in your billing cycle, to yield your finance charge for the period.

How to Calculate Finance Charges on Credit Cards?

To get a clear understanding of how to calculate finance charges on a credit card, let us illustrate it with an example.

Assume that you have an outstanding balance of Rs. 100,00 on your credit card with an APR of 20%. The DPR would be 0.0548% (20% divided by 365). If you carried this balance for a 30-day billing cycle, your finance charge would be roughly Rs. 1,644 (Rs.100,000 x 0.000548 x 30).

Reducing Finance Charges

Understanding and managing finance charges can make a significant difference to your credit card expenses. Here is how you can go about it.

Timely Payment: First and foremost, always pay your dues on time. Delayed payments not only incur a late payment fee but also lead to finance charges on your outstanding balance. Moreover, these charges are levied from the transaction date and not from the due date, further inflating your bill.

Pay More Than the Minimum Due: While paying the minimum due amount helps you avoid late fees, the remaining balance is carried forward to the next billing cycle and accrues finance charges. Therefore, make it a practice to pay more than the minimum due or, better yet, clear your dues entirely each month.

Consider Lower APR Cards: If you consistently carry a balance on your credit card, it might be beneficial to consider credit cards that offer a lower annual percentage rate (APR). Some credit card issuers might also allow you to negotiate a lower interest rate if you have been a reliable customer.

Interest-free Period: Leverage the interest-free period, also known as the grace period, offered by your credit card. This period, typically ranging from 20 to 50 days, is the time during which you would not be charged any interest on your new purchases if you have paid your previous month's bill in full. Using this wisely can help in managing your finance charges better.

Avoid Cash Advances: Cash advances or withdrawals using your credit card should be avoided as much as possible. They attract high finance charges from the day of the transaction and usually do not have an interest-free period. They also often attract a one-time fee.

Opt for EMI Conversion: If you have made a large purchase that you are unable to repay in full, consider converting it to EMIs. Many credit cards offer this feature, which allows you to repay your outstanding amount over a longer period in smaller instalments, often at lower interest rates than standard finance charges.

Conclusion

In conclusion, understanding what finance charges are and how they are calculated can help manage your credit card usage more effectively. Although these charges may seem complex at first, with some patience and careful study, they can become a manageable part of your financial knowledge.

When selecting a credit card, consider options such as Tata Capital Credit Cards, known for their transparent policies, competitive interest rates and exceptional customer service. The more aware you are of how your credit card works, the more control you have over your finances, enabling you to use credit wisely and to your advantage.

Remember, the best way to reduce finance charges is by paying your credit card balance in full and on time, and by understanding the terms and conditions of your card. Taking control of your financial life begins with understanding, and we hope this guide to finance charges in credit cards has provided you with valuable insights in this area.

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