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Basic Credit Card Terms - Part II

The most important and powerful factor in determining the true cost of your credit card is the Annual Percentage Rate (APR). This is the amount of interest charged on the card's balance expressed as an yearly rate. In order to calculate your monthly finance charge, the APR is divided into a periodic rate, usually daily.

In order to calculate the daily interest rate, simply divide the annual rate by 365.

Example: 14.99% / 365 = .04106849315% Your credit card's interest rate can be either variable or fixed. A variable rate is linked to an economic indicator such as the Prime Rate and it fluctuates with the economy. A fixed rate does not fluctuate with the economy, but is instead set by the credit card issuer. But don't let the name fool you. The rate is anything but fixed. The issuer can increase your rate whenever they want as long as they give you advance notice.

Another way your interest rate can increase is if you miss a payment or send one in late. The credit card company can use this as an excuse to jack up your rate to obscene levels.

Balance Computation Methods Credit card companies use different methods for calculating your balance. Whichever method they use, it must be clearly indicated on your statement and in the cardholder agreement. The majority of credit card companies use one of the following three methods:

1. Average Daily Balance. This is the most common calculation method. The issuer simply takes your balance from each day in the billing period, adds them all up, and then divides by the number of days in the billing period. Any credits to your account for the month are deducted, but purchases are usually not included.

2. Adjusted Balance. This is the most consumer-friendly calculation method. The issuer simply takes your outstanding balance at the beginning of the billing cycle and subtracts and payments or credits. For example, if your beginning balance was $1,000 and you made a payment of $125, interest would only be charged on the remaining $875. Purchases are always excluded when using the Adjusted Balance method.

3. Two-Cycle Balance. This is the least advantageous calculation method for consumers. It works just like the Average Daily Balance Method but it uses the prior two billing cycles instead of just the most recent.
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