Credit card finance charges are calculated using different methods by the issuer. Therefore, the credit card holder should be able to understand how each method works thus enabling him/her to choose cheaper source of credit. There are three methods of calculating credit card finance charges i. Average daily balance ii. Adjusted balance method and iii. Previous balance method Average daily balance This method calculates interest based on the outstanding balance at the end of each day.
The outstanding balance is tracked each day by adjusting for any purchases and payments made. The interest can be compounded monthly or daily depending on the terms of the credit card. If the interest is compounded daily the interest is calculated on the daily balance and added to the opening balance the following day (Street Authority: 2008). Assumption: interest compounded daily Best source of credit
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From the above calculations, it is evident that the cheapest source of credit is previous balance method. But this is the case only because Nancy made only one payment while charging more. Otherwise the best method for the credit card holder is the adjusted balance method in that it considers all payment, credits and purchases. Therefore, if Nancy had made more payments, her finance charge would be much lower under adjusted balance method. This method works best if the credit card holds repays more.
The ideal method if the credit card holders wish to increase the outstanding balance is the previous balance method, this is because the current finance charge is calculated on the previous balance which would be lower than current balance. References: Learn Money (2008). Financing Rates. Getting Technical with Interest Calculation. Retrieved on 26/2/2008 from http://www. learnmoney. co. uk/credit-cards/financing-3. html Street Authority (2008). Average Daily Balance Method. Retrieved on 26/2/2008 from http://www. streetauthority. com/terms/a/average-daily-balance-method. asp
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