Annual percentage rate and other finance charges and fees
Finance charges are generally classified into two categories: annual percentage rate (APR) and monthly periodic rate.

APR is the annual rate of interest the issuer claims a consumer will pay over the course of a year on revolving balances. APR could range from as high as 30 percent to as low as 5.9 percent. However, the stated rate is rarely the actual rate of interest, because most issuers compound interest—charge interest on interest. That means that if consumers carry a balance from month to month they will be paying a much higher APR than the issuer’s stated rate—in some cases as much as 2 to 3 percent higher.

Monthly periodic rates are the charges that consumers must pay in addition to the APR. Generally these charges are added to the current balance, and interest is charged on the additional charge as well as the balance. These charges include late fees (usually a minimum of $5 to $10—up to 25 percent of the minimum monthly payment due), over-limit fees (usually a minimum of $5 to $10—up to 25 percent of the amount over the limit), transaction fees, lost card replacement fees (usually from $5 to $25), and cash advance fees (a cash loan billed to a credit card).

The most hurtful of these charges to the consumer is the cash advance fee. Card issuers already make a considerable amount of money off cash advances because they charge interest from the first day cash is advanced, regardless of whether the balance is paid in full at the end of the month. In addition, they make even more by charging higher interest rates (from 1.5 to 5 percent more) on cash advances than on purchases. On top of that, most issuers charge a cash advance fee of up to 2.5 percent of the amount of cash advanced, with a minimum charge of from $2 to $5 per transaction.

Grace period
As defined by the Federal Reserve Board, a grace period is “the date by which or the period within which any credit extended for purchases may be repaid without incurring a finance charge.” A grace period is offered at the discretion of the credit card issuer, so not all issuers offer a grace period.

Many consumers are confused about a grace period. They often think that new purchases do not start accruing finance charges until after the grace period has expired. In fact, if any part of a balance, even one penny, is carried over from a previous month, all new purchases made during the current month will start accruing interest immediately. In addition, consumers do not generally get the whole grace period free of interest unless they meet two conditions: the entire “balance due” has been paid by the due date, and all “new purchases” have been paid in full by their due date. In short, if consumers carry a balance from month to month, grace periods do not apply, even if the issuer of the card offers one.

Balance calculation method
Card issuers have devised four main ways to determine the balance on which finance charges should be assessed: Average Daily Balance, Excluding New Purchases; Two-Cycle Average Daily Balance, Excluding New Purchases; Average Daily Balance, Including New Purchases; and Two-Cycle Average Daily Balance, Including New Purchases. Most of the national credit card issuers use the Average Daily Balance, Including New Purchases method.

With the Average Daily Balance method, every day the bank adds charges and payments to determine what is owed for that day. It adds these totals and divides that figure by the number of days in the month to determine the average daily balance. The bank then divides the annual interest rate by 12 to get to the monthly periodic interest rate. This rate is then multiplied by the average daily balance to obtain the finance charge for the month. Some banks include charges made during the month in the daily balance (including new purchases), and others exclude new purchases until the next billing period.

With a Two-Cycle Average Balance method, banks retroactively eliminate the grace period by basing the finance charges on the sum of the average daily balances for both the previous and current months. Some banks include new purchases in their daily balance calculations; others do not.

The following example shows the monthly cost difference between the four methods. We assume that a consumer starts the month with a zero balance and charges $1,000 on a credit card that has an APR of 19.8 percent. The next month the consumer pays the minimum monthly amount due, but charges an additional $1,000. By the third month, the minimum monthly payment due on the $2,000 charged varies with the four balance calculation methods. Note that in each of the four cases the balance will be paid in full in 36 months and there will be no additional purchases.

1. Average Daily Balance, Excluding New Purchases--------------$ 66.00 monthly minimum
    
2. Two-Cycle Average Daily Balance, Excluding New Purchases--$131.20 monthly minimum
    
3. Average Daily Balance, Including New Purchases---------------$132.00 monthly minimum
    
4. Two-Cycle Average Daily Balance, Including New Purchases---$196.20 monthly minimum

In a best case scenario, the $2,000 charge will cost the consumer at least $2,376. In a worse case scenario, the $2,000 charge will cost the consumer at least $7,063.

Annual fees
Annual fees, sometimes called membership fees, average about $20 annually, although some Platinum cards charge upward to $300 annually. Some cards, however, carry no annual fees. Nevertheless, issuers always get their money. Unless consumers pay the entire balance each month, they pay interest to the issuers. In addition, merchants pay issuers of the credit cards from 1.5 to 10 percent of the cost of all items charged on the card, just for the privilege of accepting the card.

Conclusion
Although it may seem that credit card issuers have multiple ways of capturing consumers’ money, there are ways to lower credit card costs: switch to a low APR credit card with no annual fee, make sure the entire balance is paid monthly before the due date and do not allow a balance to be carried over into the next month, and do not take cash advances against the credit card.