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CONTENTS
Definition of Terms
Calculation of Finance Charge
Credit Card Owner's Checklist
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| SHOP. Smart consumers do comparison shopping when looking for credit such as a
mortgage or an auto loan. It is also a good practice to engage in when
shopping for a credit card plan, because the choices you make could save
you money.
SHOP among the various plans of credit card issuers contained in this
article. Compare them with cards you already have and with offers you
receive in the mail for the terms that best suit your spending and
repayment habits. The costs and terms of the plan or plans can make a
difference to how much you pay for the privilege of borrowing.
In the disclosure form from the credit card issuer, key credit terms
to consider are the annual percentage rate (APR), annual fee, and grace
period. Also consider credit terms such as cash advance fees, late
payment charges, and over-the-limit fees.
Take these items into consideration along with how you pay your bills
each month, whether in full or only partially. You could save yourself
some money.
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Definition
of Terms |
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Annual
Fee
A flat, yearly charge similar to a membership fee
Annual Percentage Rate
(APR)
A measure of the cost of credit that expresses the finance charge, which
includes interest and may also include other charges, as a yearly rate.
Finance Charge
The dollar amount you pay to use credit. Besides interest costs, it may
include other charges associated with transactions such as cash advance
fees.
Grace Period
A time, about 25 days, during which you can pay your credit card bill
without paying a finance charge. Under almost all credit card plans, the
grace period only applies if you pay your balance in
full each month. It does not apply if you carry a balance forward. Also,
the grace period does not apply to cash advances.
Interest Rate
Interest rates on credit card plans change over time. Some are
explicitly tied to changes in other interest rates such as the prime
rate or the Treasury Bill rate and are called variable rate plans. Others are not explicitly tied to changes in other interest rates
and are called fixed rate plans. |
Variables
and Impact
Calculation
of Finance
Charge |
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It is helpful to know how the credit card
issuer will calculate the finance charge on your credit card bill. To
determine the finance charge, an issuer will apply a periodic rate to a
balance. Card issuers use different balance calculation methods such as:
the average daily balance method, the previous balance method, and the
adjusted balance method.
With the average daily balance method (the most
common method), the issuer calculates the balance by taking the amount
of debt you had in your account each day during the period covered by
the billing statement and averages it. With the previous balance
method, the issuer uses the balance outstanding at the end of
the previous periodóthat is, the period prior to the one covered by
the billing statement. With the adjusted balance method,
the balance is derived by subtracting the payments youíve made from
the previous balance. |
Combinations
to Consider |
Smart consumers find the best deal for their budgets and repayment
style. For example, if you always pay your monthly bill(s) in full, the
best type of card is one that has no annual fee and offers a grace
period for paying your bill without paying a finance charge.
If you donít always pay off the credit card balance monthly, be
sure to look at the periodic rate that will be used to calculate the
finance charge.
Credit card issuers that offer variable interest rate plans derive
the rate to be charged to the consumer by using a formula. Two of the
most common formulas are:
Some of the more common indexes used by credit card issuers are the
prime rate, the one, three, or six-month Treasury Bill rate, the
federal funds or Federal Reserve discount rate. Most of these indexes
can be found in the money or business section of major newspapers. Once
the interest rate corresponding to the index has been identified, the
issuer then adds a number of percentage points, the ìmarginî, to
this index rate to calculate the rate charged.
In some cases, the issuer might elect to use another formula to
determine the rate to be charged to the consumer. The issuers multiply
the index or index plus the margin by another number, ìthe multipleî,
to calculate the rate charged.
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Possible
Savings |
The following is an example of the annual
savings you could achieve by switching to a credit card plan with a lower
interest rate and no annual fee.
Assumption
In this example, the average monthly balance carried forward equals
$2,500, which is about the national average for consumers with credit card
debt.
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Plan
Descriptions:
| Terms |
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Plan A |
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Plan B |
Average
monthly balance |
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$2,500 |
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$2,500 |
| APR |
x |
.18
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x |
.14
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Amount paid in
finance charges
annually |
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$450 |
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$350 |
| Annual Fee |
+ |
$ 20
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+ |
$ 0
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| Total Cost |
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$470 |
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$350 |
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In this example, the total possible savings each year achieved by
selecting a credit card plan with a lower interest rate and no annual fee
is ($470 ñ $350) $120.
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Credit
Card
Owner's
Checklist |
If you are applying for your first credit card
or have several cards already, here are some helpful tips you might want
to follow in shopping for a credit card.
- Review all of the information about the plans.
- Draft a list of desired features that best fit your needs
and rank them according to how you plan to use the card.
- Call the institutions you've selected to verify the
information and to see if they have any other plans available.
- If you are a current card holder and have a good credit
rating, see if the institution that issued your card will
lower your current rate. Negotiate for a better deal!
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