The credit card with the lowest interest rate can cost you more than you expect. Although the interest rate is important, it’s just as important to understand how the card issuer computes the monthly finance charges.

You need to know whether finance charges are based on a daily or monthly basis, whether there is a grace period for new purchases and how monthly payments are applied. Most consumers, however, focus primarily on the interest rate.

Just recently, I heard from a consumer who was frustrated because his finance charges went up even though his interest rate and monthly balance declined. “The company charged me twice the dollar amount of finance charges even though my balance was half the size it was the previous month and the interest rate was three percent lower. On both statements, the credit card company based the finance charges on the average daily balance on my account.

“But on the first statement, the company used the average daily balance for one billing cycle. On the next statement, it combined the average daily balance for the current and the previous billing cycle,” he explained.

The method your credit card company uses to determine your outstanding balance makes a big difference in the finance charges you pay. Your outstanding balance may be calculated over one or two billing cycles; using an adjusted balance, average daily balance or previous balance; and either with or without new purchases in the balance.

How do these methods of calculating finance charges affect the cost of credit? Here are examples from the Federal Trade Commission:

Suppose your monthly interest rate is 1.5 percent, your APR is 18 percent, and your previous balance is $400. On the 15th day of your billing cycle, the card issuer receives and posts your payment of $300. On the 18th day, you make a $50 purchase. Using the:

* Average Daily Balance method (including new purchases), your finance charge would be $4.05.
* Average Daily Balance method (excluding new purchases), your finance charge would be $3.75.
* Average Daily Balance Double Cycle method (including new purchase and the previous month’s balance), your finance charge would be $6.53.
* Adjusted Balance method, your finance charge would be $1.50.

In general, you’ll have lower finance charges with one cycle billing and either the average daily balance method excluding new purchases, the adjusted balance method or the previous balance method. Credit card issuers can change the terms and conditions on your account at any time, so it is important to read everything you receive from them to avoid surprises.

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