Methods of Charging Interest
Annual percentage rate is the principal means of comparing credit products. Because interest is compounded on a periodic basis (daily or monthly), to calculate charges on a credit card account the APR has to be de-compounded. Most major banks use the following methodology:
Increase the figure to the highest possible value while still meeting advertising requirements. e.g., if a card is advertised at a percentage rate of 17.9, then any value up to 17.949% will still be rounded down to 17.9%, and thus still be correct. Once this number has been derived, it must be converted to a decimal multiplier – in this case the number would be 1.49575%. This is a monthly periodic rate derived by dividing the APR by 12. This number will provide you with a rate which, when compounded over a year, will equal the EAR.
At this point, it is important to round down – because the APR has already been maximised in order to make use of the highest rate possible, rounding any figures up might push the APR over the edge and onto a higher rate, leaving the card issuer liable for false advertising claims.
This method is subject to change, depending on the bank in question, and is highly influenced by cardholder perceptions and bank strategy, sometimes with a value of simplicity for cardholders; other times with the effect of obfuscating the true interest rates charged.
Methods vary by country because of customs and laws. A brief summary of each of the four methods given under U.S. Regulation Z follows. This list is followed by a few examples from other countries and some discussion of differences between the various methods:
Read more about this topic: Credit Card Interest
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