Credit Cards

Credit Cards are used throughout the world to purchase goods and services instead of cash money. This material is to discuss some of the concepts of the credit card.

Annual Percentage Rate (APR): The annual interest rate associated with the credit card.

Credit Limit: The maximum amount allowed charged on a credit card.

Transaction Fee: Fees charged to the customer for late payments, exceeding the credit limit, or other non-interest fees.

Periodic Rate: The Annual Percentage Rate divided by the period used to calculate the balance (usually 365).

Purchases: Charges on a credit card from purchasing goods and services.

Cash Advances: Charges on a credit card from cash received.

Balance Transfers: Charges on a credit card from transfers from other accounts.

Finance Charge: The total amount to be paid in transaction fees and interest.

Grace Period: The period of time in which if the new balance of a credit card is paid off, there is no finance charge.

An idea that was touched on above but not discussed is an important one. That is, how is the interest on a credit card calculated? Most widely used credit cards (Visa, Mastercard, etc) use the Average Daily Balance approach to finding the amount of interest on purchases during a period of time.

Let's say we have this credit card statement:

Tingling National Bank Credit Card Covering the Period April 15 through May 14 APR = 22.9% Beginning Balance: $240.00
DATE	TRANSACTION	AMOUNT
4/18	Peasant Pastures Gas	$10.00
4/23	Blue Mollusk Seafood Restaurant	$35.00
5/01	Payment Received	$100.00
5/10	New Army Clothing Store	$65.00

What is the amount of interest for this period?

The first thing we must find is the Average Daily Balance.

From April 15 through April 17, the balance is $240.00 (3 days)

From April 18 through April 22, the balance is $240.00 + $10.00 = $250.00 (5 days)

From April 23 through April 30, the balance is $250.00 + $35.00 = $285.00 (8 days)

From May 1 through May 9, the balance is $285.00 - $100.00 = $185.00 (9 days)

From May 10 through May 14, the balance is $185.00 + $65.00 = $250.00 (5 days)

To find the Average Daily Balance, we must average the above:

$240* 3 + $250 * 5 + $285 * 8 + $185 * 9 + $250 * 5

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= $238.83

The amount of interest is obtained using the Simple Interest Equation: I = Prt. The principal is the average daily balance. The rate is the annual percentage rate. The time is in years, thus the time is the number of days divided by 365.

I = Prt

I = $238.83(.229)(30/365)

I = $4.50

Therefore the interest for this account for this period is $4.50.

Let's look at another statement:

Weripoff National Bank Credit Card Covering the Period July 23 through August 24 APR = 19.8% Beginning Balance: $174.76
DATE	TRANSACTION	AMOUNT
7/25	McReynold's Restaurant	$11.45
7/28	Washington Merlins Basketball Tickets	$212.00
7/31	Payment Received	$200.00
8/12	High's Black Swamp Theatres	$31.75
8/20	WEW Cooked Wrestling Tickets	$150.00

What is the amount of interest for this period?

From July 23 through July 24, the balance is $174.76 (2 days)

From July 25 through July 27, the balance is $174.76 + $11.45 = $186.21 (3 days)

From July 28 through July 30, the balance is $186.21 + $212.00 = $398.21 (3 days)

From July 31 through August 11, the balance is $398.21 - $200.00 = $198.21 (12 days)

From August 12 through August 19, the balance is $198.21 + $31.75 = $229.96 (8 days)

From August 20 through August 24, the balance is $229.96 + $150.00 = $379.96 (5 days)

The Average Daily Balance is:

$174.76* 2 + $186.21 * 3 + $398.21 * 3 + $198.21 * 12 + $229.96 * 8 + $379.96 * 5

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= $249.11

The amount of interest is:

I = Prt

I = $249.11(.198)(33/365)

I = $4.46

Therefore the interest for this account for this period is $4.46.

These two examples show the amount of interest to be, I would say, reasonable amounts. Of course this is only one month's worth of interest and many of us have higher balances than the one's above. Remember, the Average Daily Balance approach is used to determine the interest on purchases. Interest obtained from the use of cash advances and balance transfers may be obtained another way, usually with an entirely different Annual Percentage Rate. In fact, most cash advances the Compound Interest Formula compounded daily.

Exercises

1. Find the average daily balance and the amount of interest from purchases for the credit card account below:

Tingling National Bank Credit Card Covering the Period January 11 through February 10 APR = 15.5% Beginning Balance: $200.00
DATE	TRANSACTION	AMOUNT
1/17	Payment	$80.00
1/20	Purchase	$35.00
2/01	Purchase	$100.00
2/04	Purchase	$45.00

2. Find the average daily balance and the amount of interest from purchases for the credit card account below:

Tingling National Bank Credit Card Covering the Period November 17 through December 17 APR = 16.9% Beginning Balance: $1231.24
DATE	TRANSACTION	AMOUNT
11/25	Purchase	$65.21
11/30	Purchase	$11.48
12/6	Purchase	$163.95
12/13	Payment	$300.00

3. Find the average daily balance and the amount of interest from purchases for the credit card account below:

Tingling National Bank Credit Card Covering the Period October 10 through November 9 APR = 9.9% Beginning Balance: $569.18
DATE	TRANSACTION	AMOUNT
10/19	Purchase	$23.99
10/22	Purchase	$100.00
10/31	Purchase	$65.50
11/2	Payment	$20.00
11/6	Purchase	$78.06

Answers

1. $202.74; $2.67

2. $1301.36; $18.68

3. $673.54; $5.66

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