Manage Your Money, Lesson 4: How Much Credit Can You Afford?, Choosing a Credit Card

Ohio State University Extension/Research

Manage Your Money

Lesson 4: How Much Credit Can You Afford?

MYM-3-03

Choosing a Credit Card

Shop around when you choose a credit card. Card issuers differ in the fees, charges, and benefits they offer. You may use Worksheet 4-D to record the facts. Consider these important features:

Annual Percentage Rate (APR). APR is the cost of credit expressed as the yearly interest rate (used to figure the finance charge on the outstanding balance for each billing period). The cost of credit depends on where you borrow, your credit history, how much you borrow, and how long you take to repay it. Credit costs will vary from lender to lender. Before you borrow, compare the costs at several places.

shopping cart full of credit cards Some credit card agreements allow the issuer to change your APR based on changes in economic indicators. These indicators are called indexes. These plans are called "variable rate" programs. The card issuer must tell you that your credit card rate may change and how the rate is determined. They must tell you which "index" is used and what additional amount (margin) is added to your new rate. You should also receive information about any limitation on how much and how often your rate may change.

The APR may also be raised if you fail to pay your bill on time or violate some other provision of your credit agreement/contract. Be sure to read and understand all of the "fine print."

Annual Fees. Some card issuers charge an annual fee to use their credit card. These fees range from $15 to $55. However, some cards have no annual fee.

Transaction Fees and Other Charges. Some card companies charge a fee for cash advances, fees for being over the balance limit, fees for late payment, or may charge a fee for every month you use the card. Check out these fees before deciding on a card.

Grace Period. The time between the date of purchase and the date interest starts being charged on that purchase is the grace period. If you pay your current balance in full within the stated grace period, no interest is charged for the new purchase. Some card companies offer no grace period, and the finance charge is imposed from the date you used your card or from the date the transaction was posted on your account. If you carry a balance rather than paying off your card in full, you won’t get a grace period on new purchases. Cash advances generally have no grace period.

Method	Amount Owed at Start of Billing Cycle (Feb. 1)²	Payment (Feb. 14)	Amount Outstanding at End of Cycle (Feb. 28)	Basis for Finance Charge 11/2%	Actual Finance Charge for Month
Table 4-A: Four Methods of Computing Finance Charges on Open-end Credit Accounts¹
Adjusted Balance	$400	$200	$200	$200	$3.00
Previous Balance	$400	$200	$200	$400	$6.00
Average Daily Balance	$400	$200	$200	$300	$4.50
Two-Cycle Average Daily Balance	$400	$200	$200	$300	$7.50
	Average daily balance from last billing cycle			+$200
	Sum of current and last period daily balance			$500
¹Open-end credit includes credit cards, department store charge plates and check overdraft accounts. Open-end credit can be used continuously, generally until the pre-arranged credit limit is reached. Truth-In-Lending laws require that creditors tell you the method of calculating the finance charge and the date the finance charge begins. ²Assuming that January 31 was the closing date of the original cycle. Source: Sharon B. Seiling, Ph.D., and Carolyn McKinney, Ph.D., Money Talks, Ohio State University Extension, 12/89.

Computing the Balance for the Finance Charge. If you carry a balance from month to month on your credit card, it is important to know what method is used to calculate the finance charge. There are four common methods of computing finance charges, defined below and compared in Table 4-A above.

Average Daily Balance (most commonly used). This method credits your account from the day payment is received by the credit issuer. The issuer starts with the beginning balance for each day in the billing period and subtracts any credits made to your account that day. Depending on the plan, new purchases may or may not be added to the balance. Typically cash advances are included. The resulting daily balances are added for the billing cycle. Then the total is divided by the number of days in the billing period to get the average daily balance.

Adjusted Balance (least expensive). Usually this method is most advantageous for card holders. The balance is determined by subtracting payments or credits received during the billing period from the balance at the end of the previous billing period. Purchases made during the billing period are not included.

Previous Balance. Finance charges are based on the amount you owed at the end of the previous billing period. Payments, credits, and new purchases made during the current billing period are not included.

Two-cycle Balances (most expensive). This method uses the account activity for the last two months to calculate finance charges. This is probably the most expensive if you carry a balance from month to month.

Customer Service and Other Benefits. Nearly all credit card companies have 24-hour toll-free telephone numbers to assist card holders with problems. Other special services might include credit card protection, rebates, discounts, insurance, special merchandise, or possibly airline miles.

Truth-In-Lending. The law requires that a lender provide you with the following information:

The annual percentage rate (APR).
How the APR will be determined (if it is a variable rate).
The method of computing the balance at the end of each month.
The annual fee to be charged, if any.
The minimum finance charge.
Any transaction fee for purchases or cash advances.

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Written by Ella Mae Bard, Extension Agent in Family & Consumer Sciences, Knox Co., Carolyn McKinney, Family Resource Management Specialist, Consumer & Textile Sciences Dept., Nancy Hudson, Northeast District Family & Consumer Sciences Specialist, and Diane Johnson, Extension Agent in Family & Consumer Sciences, Darke Co., Ohio State University Extension. Portions adapted from "Managing Your Money," prepared (1994, 1996) by Eleanor Ames, former OSU Extension Agent (Madison Co.) in Family & Consumer Sciences.

For more information about family life issues, visit http://families.osu.edu

Manage Your Money is a six-part self-study course. The lessons include:

Getting Started
Where Does Your Money Go?
Stop Spending Leaks

How Much Credit Can You Afford?
Develop Your Budget
Your Net Worth and Financial Records

Appreciation is expressed to Marjorie McCullough, Office Associate, Consumer and Textile Sciences Department, who worked with several drafts of these materials.

This material is intended only for educational purposes. Mention of a proprietary product, trademark or commercial firm in text or figures does not constitute endorsement by Ohio State University Extension and does not imply approval to the exclusion of other products, firms, or organizations. For specific, consult your financial or legal adviser.

All educational programs conducted by Ohio State University Extension are available to clientele on a nondiscriminatory basis without regard to race, color, creed, religion, sexual orientation, national origin, gender, age, disability or Vietnam-era veteran status.
Keith L. Smith, Associate Vice President for Ag. Adm. and Director, OSU Extension.
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