What are Finance Charges in Credit Card?

12 MAY, 2023

Credit cards are versatile financial tools that allow you to purchase without cash. As the lender offers you a large sum, they want compensation in case of missed payments. It includes finance charges on credit cards. These charges can quickly increase your monthly credit card bills, leading to high debts and financial stress. This blog will discuss what finance charges mean on credit cards, how they are calculated, and tips for reducing them.

What are Finance Charges in Credit Cards and their Type?

Credit card finance charges are the fees that banks like Kotak Mahindra Bank charge for using their credit card services. These fees are added to the outstanding balance on the card and are calculated based on the card's annual percentage rate (APR).

Your credit card finance charges are calculated differently for each credit card, so understand the terms and conditions of your card to avoid paying high fees. The following are the types of finance charges on credit cards.

1. Interest Charges: This is the most common finance charge on credit cards. Interest charges apply to the outstanding balance of your credit card. The applicable rate is calculated based on the APR of the card and varies from card to card.
2. Cash Advance Fees: This fee is charged when you withdraw cash from an ATM using your Kotak credit card. These fees might be slightly higher than interest rates. So use this credit card feature wisely concerning the applicable finance charges.
3. Balance Transfer Fees: This is the fee charged when you transfer your outstanding balance from one credit card to another. Balance transfer fees are usually charged as a percentage of the transferred balance.

How are Finance Charges Applied to Credit Cards?

Banks like Kotak Mahindra Bank use different methods to calculate finance charges on credit cards. It is essential you understand the techniques. The following are the most common methods used to calculate finance charges on credit cards.

1. Daily Balance Method: This method computes the finance charge based on your credit card's daily balance. The daily ratio adds up your card balances for each day of the billing cycle, and we divide them by the number of days in the billing cycle.
2. Average Daily Balance Method: The finance charge with this method is calculated using the average daily balance of your credit card. The average daily ratio is calculated by adding the balance on your card each day of the billing cycle and dividing it by the number of days in the billing cycle.

Key Factors that Affect Credit Card Finance Charges

Several factors affect the finance charges on your credit card. It is essential to know about these factors and avoid paying high fees. The following are the key factors that affect credit card finance charges.

• APR (Annual Percentage Rate): The APR of your credit card is the primary factor that determines the finance charges. The higher the APR, the higher the finance charges.
• Credit Card Balance: The balance on your credit card also affects the finance charges. The higher the ratio, the higher the finance charges.
• Payment History: Your payment history affects your credit score, affecting your new credit cards' APR and finance charges. So maintain timely payments to reduce finance charges.
• Credit card interest-free or grace period - This period generally spans from the billing cycle's closing date to the credit card statement due date. You'll have enough time to pay the card's bill without any interest during this period.

Tips for Avoiding or Reducing High Finance Charges on Credit Cards

Now that we have discussed what finance charges are and how they are calculated, let us discuss some tips for reducing them.

1. Making payments on time: Paying on time can help you avoid late payment fees and reduce finance charges.
2. Paying off balances in full: Paying off your monthly balance can help avoid interest charges.
3. Choosing a credit card with a lower APR: Choosing a credit card with a lower APR can help you reduce finance charges. Kotak Mahindra Bank offers Kotak Privy League Signature Credit Card, Kotak White/White Reserve Credit and more.
4. Avoiding cash advances: Avoiding cash advances can also save you money on fees and interest rates.

Also Read: How is Interest Charged on a Credit Card

Conclusion

Finance charges on credit cards can quickly add up and lead to high debts and financial stress. You must understand finance charges, how they are calculated, and the factors that affect them. By following the tips discussed in this blog, you can avoid or reduce high finance charges on your credit card. So check your credit card usage regularly and make informed decisions to manage your finances effectively.

Credit Card Finance Charges FAQs

Q1. How are finance charges calculated?

Finance charges on credit cards are calculated based on the APR of the card and the outstanding balance on the card. At Kotak Mahindra Bank, we use different methods to calculate finance charges, such as the daily and average daily balance methods.

Q2. What Fees are Included in a Credit Card Finance Charge?

Cash advances, balance transfers, and late payment fees are all examples of credit card finance charges. Cash advance fees apply when you withdraw cash with your credit card, whereas balance transfer fees apply when you transfer a balance from one credit card to another. Late payment fees are assessed when you fail to make your minimum payment on time. All of these are included in your bills as finance charges.

Q3. What is the formula for credit card finance charges?

The finance charge formula is Finance charge = Carried unpaid balance × Annual Percentage Rate (APR) / 365 × Number of Days in Billing Cycle. Let's assume that you made a purchase of INR 10,000 on your credit card on March 1st, 2023, and an interest rate of 3% per month applied, and as of March 27th, 2023, your outstanding balance on the credit card is INR 5,000 since you failed to pay the full balance. There are 27 days between March 1st, 2023 and March 27th, 2023. As per the formula, the finance charge will be: INR 41.37 = (27 x 5,000 x 0.03 x 12)/365.