What is the 'Previous Balance Method'

The previous balance method describes a credit card accounting method where interest charges are based on the amount owed at the end of the beginning of the billing cycle. The previous balance method charges interest based on the amount of debt the consumer carries over from the previous billing cycle to the new billing cycle. The cardholder's APR is divided by 12 to determine the monthly interest rate, and the previous balance is multiplied by the monthly interest rate to get the finance charge for the current billing cycle. This method can be more expensive for consumers who are in the process of paying down debt because payments don't immediately reduce the amount of interest owed.

BREAKING DOWN 'Previous Balance Method'

The interest you owe when you carry a credit card balance can be calculated in different ways and can vary from card to card. The cardholder agreement will state the method your credit card company uses to calculate how much interest is owed. The most common methods are the previous balance method, the daily balance method, the average daily balance method, the adjusted balance method and the ending balance method. If you carry credit card debt, you should choose a card with both a low APR and a favorable method of calculating interest based on your pattern of making purchases and payments.

The advantage of the previous balance method is that charges to an account made during the billing cycle won't lead to a higher finance charge. The downside is that payments during the billing cycle also won't lower your finance charge.

When a credit card issuer uses the previous balance method to calculate finance charges, balances carry over to the next billing cycle, so activity this month affects finance charges for the next month.

The previous balance method can be more expensive than other types of finance charge calculation methods. If a credit card issuer uses this method, a cardholder can minimize the amount paid in finance charges each month by paying more than what they charge during the month.

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