What Is a Purchase Finance Charge on a Credit Card?
Understand credit card purchase finance charges: what they are, how they're calculated, and when they apply to your account.
A purchase finance charge on a credit card represents the cost of borrowing money for purchases when the full balance is not repaid. Understanding this charge is important for credit card users to manage their financial obligations and avoid unexpected expenses.
Understanding Purchase Finance Charges
A purchase finance charge is the interest a credit card issuer charges on the outstanding balance of purchases. This charge applies to the portion of your purchase balance that remains unpaid after the due date. While a credit card statement may include various fees, a purchase finance charge is distinct because it is directly tied to the interest accrued on purchases. This charge compensates the credit card issuer for the risk and cost of lending money. You will see this charge listed on your credit card statement under headings like “finance charge” or “interest charge.” It reflects the ongoing cost of carrying a balance.
Key Components and Calculation
The amount of a purchase finance charge is determined by the Annual Percentage Rate (APR) and the average daily balance. The APR is the yearly interest rate applied to your outstanding balance, which credit card companies convert into a daily periodic rate for calculations. Different APRs might apply, such as an introductory rate or a standard purchase APR, influencing the total cost.
Credit card companies commonly use the average daily balance method to calculate finance charges. This method involves summing the outstanding balance for each day in the billing cycle and then dividing that total by the number of days in the cycle. This provides an average balance upon which the interest is calculated. To determine the finance charge, the average daily balance is multiplied by the daily periodic rate and the number of days in the billing cycle. The daily periodic rate is derived by dividing the APR by 365. The length of your billing cycle directly affects the period over which this daily interest accrues.
When Purchase Finance Charges are Incurred
Purchase finance charges are incurred when the full statement balance is not paid by the due date. Many credit cards offer a “grace period,” usually at least 21 days, between the end of a billing cycle and the payment due date. During this grace period, interest is not charged on new purchases if the entire statement balance from the previous cycle was paid in full.
If you fail to pay the full statement balance by the due date, you will generally lose this grace period for new purchases. Consequently, interest will be applied to the unpaid purchase balance, often starting from the transaction date. This means recent purchases can begin accruing interest immediately if a balance is carried over.
Grace periods usually apply only to purchases. Transactions such as cash advances or balance transfers typically begin accruing interest from the day they are posted to your account, without a grace period. Paying your credit card balance in full each month is the most effective way to avoid purchase finance charges and to maintain your grace period.