Which Credit Card?

Credit cards are readily available to almost anyone today. Look around your class rooms and you'll probably find "opportunities" to apply for VISA, MasterCard, department store cards, Discover Card, These cards keep you from having to apply for credit every time you make a purchase. They are very handy, but their convenience can result in long-term debt if you don't understand how the interest is calculated. This is one case where ignorance is not bliss, and a bit of knowledge can save you plenty. When you charge a purchase on a credit card, you are, of course, borrowing money. Some credit cards charge you interest from the day of purchase, but most have a grace period during which no interest is charged on the amount you borrowed. If the balance is paid in full within this grace period (usually about 25 days), then no additional interest will be charged. But if some of the balance is still unpaid at the end of the grace period, then a relatively high rate of interest is charged. More than just the interest rate must be considered, though, when you choose which card to use.

 Here's a story from 1990: I went on an extended trip and was not home when my credit card bills arrived in the mail. I had charged almost identical amounts on two different cards, and, not realizing that the grace period had expired, continued to use the cards for purchases and hotel expenses. I intentionally alternated use of the cards so as to avoid reaching my credit limit on either card. When I returned, I had a second bill from each card company and, even though the total charges on each card differed by less than a dollar and each charged 14.9% interest, one bill was quite a bit larger than the other! What happened here? How can the finance charge on almost-identical purchases differ for two credit cards that charge the same interest rate? The answer lies in that there are several ways in which credit card companies determine the balance on which interest you pay is computed each month. Here are the three methods of computing interest on credit cards.

Using the Average Daily Balance (ADBx) Excluding New Purchases method, interest is paid only on any balance remaining from the previous month. You get about 25 day's grace before interest starts accruing on new purchases, even if you didn't pay your balance in full. This is uncommon today.

  1. The Average Daily Balance (ADBi) Including New Purchases
    1. No grace period method a local bank offered one without a grace period and interest was charged from the day of purchase even if you did not carry a balance.
  • With a grace period, as is more common, this method is very similar to the first (ADBx), with this exception: If any balance remains unpaid from a previous month, that balance is subject to interest. Furthermore, there is no grace period for new purchases - interest is charged from the day of purchase.
  1.  Under the Two-Cycle Average Daily Balance Including New Purchases method, as in II above (ADBi), there is no grace period on new purchases if you have a remaining balance. In addition, the grace period for the first month is eliminated retroactively and compound interest is applied when you fail to pay your bill in full.Not currently allowed 9/01/201

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Use the following examples to help you with your project!!

Example: Suppose you charge a $300 condo rental bill on August 1 and a $200 auto repair on September  You are sent a bill in September for the August charge, but you are not home to pay it. On your return, you pay your October bill in full. (That is the bill for the period ending September 30.) The annual interest rate is 15% (0.15 / 12 = 0.0125 interest/month). Find the finance charges for each method.

ADBx method

You have No interest on the $300 charge on the first (September) bill and Interest on the $300 charge only on the second bill. So in October, you pay the principal + one month's interest on the $300 charge and principal on the $200 charge = $300 + ($300)(0.0125) + $200 = $503.75.

ADBi method

No interest is charged on the $300 charge on the first (September) bill and Interest on the $300 charge and the $200 charge on the second bill. So in October, you pay the principal + one month's interest on the $300 charge and principal + daily interest on the $200 charge

= $300 + ($300)(0.0125) + $200 + ($200)(0.0125) = $506.25.

Notice that this can also be calculated as

$300(1+.0125) + $200(1 + .0125) = $506.25, or $500(1+.0125) = $506.25.

The  Project

  1. Research

Credit card laws as the laws vary from state to state. What states have a cap on how much interest a Credit card company can charge? What states have no cap?

  1. Which of the above methods for calculation interest are most consumer friendly?
    1. Which are the laws card companies must abide by when targeting students?
    1. What is the difference between a secured and non-secured credit card?
    1. What is the difference between the APR and the APY
  1. Get twocurrent credit card applications for aparticular card. The credit cards must have different rates.(DO NOT APPLY FOR THE CARD)You can use your own bank. Do not use one of the "introductory" rates that expire after a period of card use.
    1. Complete the credit card information sheet for both cards.
    1. Write a summary statement about the proís and conís of each card.
    1. What card do you think is better and why 
  1. Usingboth of the above cards interest rate, solve the following problem and write a report on a word processor detailing the cardassumed, the interest rate, and your solution. You must attach a copy of your spreadsheet.

Here's the problem:

  1. On May 1st, you charged a $1450 doctor bill for the ankle you sprained while hiking. You also charged the$50 crutches you got at the drug store that day. On June 1st, you charged your $400 plane ticket neededto get home for the summer. On June 3rd, your bill came in the mail for the month of May, and offeredyou the option of paying nothing for the month since your "credit management has been exemplary"- andreminding you that if you choose to pay nothing, your interest will continue to be charged as in yourcardholder's contract.

Part 1: If you decide to accept the company's generosity, and pay the whole bill in July, what will thedecision to delay payment cost you? Solve the problem for each of the twocards you have chosen of determiningbalance. You do not need to do this part in excel. Just include it in your paper. Most of you have a card that uses the ADBi method. See above for an example.

Part 2: Suppose you decide to pay $100 per month, starting on July 3rd (the day of arrival of the next bill),and to pay nothing in June. It will take you a while to pay the whole bill. Construct, for each method ofdetermining the balance, an amortization table for the period of time until the total bill is paid. Use aspreadsheet. Your report should contain three tables, each with headings and first lines looking like the onebelow. You should fill in the *'s and the rest of the table.

Bill Amount Interest Principal Balance before Balance with

ADBi  Method Ė Card Name
Bill NumberAmount PaidInterestBalance Before Interest is addedBalance with interest added
0 (May)$0$0  $500
1 (June)$0$0$900$905
2 (July)$100$10$815$825

Of course, the Interest column entry plus the Principal column entry should equal the Amount columnentry of $100. Continue your table until the balance is zero (or less). Make sure your report includes ashort summary, comparing and contrasting the different methods.

Other features of credit card contracts are interesting. Some credit companies charge an annual fee forthe use of the card. Some have a minimum finance charge. These features must also be considered whenchoosing a card.

  1. Paper
    1. Write about the current credit card laws
    1. Summary statement about the proís and conís of each card.
    1. Summary of  what card do you think is better and why
    1. Summary of what you learned about credit cards.
    1. Final thoughts cards