October 14, 2005

Family Finance Supplement

Choose the best credit card for your family

By Barbara Rowe

Many Americans are addicted to credit cards. The average household has at least four, and invitations to sign up for more arrive in the mail every day. However, shopping for the best credit value is more complicated than ever. Not all credit cards are alike. Before selecting a credit card, it is important to understand credit card terms and to compare the costs of similar cards to get the features and terms you want from your credit option. Each affects the cost of the credit you will be using.

Credit card terms

Annual percentage rate—The annual percentage rate, or APR, is the interest rate that the card issuer charges on the unpaid balance of the credit cards. Some cards have set rates; other cards have variable rates, where the amount of interest changes. The interest rate is noted on the disclosure statement that you receive when you apply for a card and again when you open the account. It also is noted on each bill you receive. If a credit card has an unbelievably low rate, it probably is an introductory rate, meaning that the rate is in effect for a short period of time—six months to a year. After the introductory period is over, the rate will increase. If you carry a balance on your credit card, you will want to look for a credit card with a low rate. However, be careful that you do not obtain a low rate that is offset by a high annual fee.

Annual fees—Some credit card issuers charge annual membership fees. These fees range from $25 to $75 or more for premium cards, but cards with no annual fees are available. Lists of no-fee cards are available at many websites.

Grace period—This is the length of time you have to pay your bill before interest is charged on the purchases.

Some cards do not offer grace periods; finance charges begin from the date you use your card or from the date each credit card transaction is posted to your account. Most card issuers offer 25-day grace periods if the card was paid in full on time the month before.

Finance charge—The total dollar amount paid to use a credit card, including interest costs, service charges, and transaction fees.

Transaction fees and other charges—Credit card issuers may also charge other fees. For example, using the card to obtain a cash advance, failing to make a payment on time or going over your credit limit all usually result in fees, some of them costly. Some issuers charge a flat monthly fee whether or not you use the card. Carefully read the disclosure statement you receive when you apply for the card to see what other service fees may be charged.

Calculating the finance charge

If you expect to carry a balance on your credit card account, it is important to know how the card issuer will calculate your finance charge. This charge will vary depending upon the method the card issuer uses to figure your balance. The method used can make a big difference in how much finance charge you will pay, even when the APR is identical to that charged by another card issuer and the pattern of purchases and payments is the same.

Average daily balance—This is the most common plan used by credit card issuers. Under this method, the sum of the outstanding balances owed each day during the billing period is divided by the number of days in the period. The periodic rate (the APR divided by 12) is applied against that balance.

However, the average daily balance can exclude new pur-chases, include new purchases with a grace period, or include new purchases with no grace period. How the average daily bal-ance is calculated dramatically affects finance charges.

Two-cycle average daily balance—This method uses the total of the average daily balances for two billing cycles even if you paid the balance off the previous month. In effect, this method doubles the finance charge. To avoid finance charges, you must pay off your balance for at least two months.

Adjusted balance—Here the balance for finance charges is computed by subtracting any payments you made and any credits you received during the present billing cycle from the balance you owed at the end of the previous billing cycle. New purchases are not included, you have until the end of the billing period to pay part of your balance and you avoid additional interest charges on the portion that you paid. This method is usually most advantageous to cardholders.

Previous balance—Finance charges are figured on the balance you owe at the beginning of the billing cycle without taking into account payments made during the current cycle.

(Barbara Rowe is an Extension specialist with Purdue University in West Lafayette, Ind. This article was adapted from Credit Card Smarts, a series published by the University of Illinois Extension.) †

Local site Links: