Something I Didn’t Realize About Credit Card Interest Charges

Filed Under: Credit Cards

I’d like to think I’m pretty well versed on credit cards, though one thing I’ve never paid much attention to is interest rates. I realize interest rates are of interest (no pun intended) to many people in the country, given how common it is for people to carry a balance on credit cards.

While I think rewards credit cards are great for a majority of people, if you’re someone who can’t control your spending with credit cards, you absolutely shouldn’t get them. Paying 15%+ interest rates will more than offset any rewards you might earn. I realize there are strategic ways to take advantage of credit cards with 0% interest rates for a limited amount of time, though even that comes with downsides (it increases your credit utilization, which could harm your credit score).

All that being said, yesterday Andrew made me aware of something related to credit card interest rates that I wasn’t previously aware of. And I’m kind of surprised by it.

Say you have a credit card with a $1,000 statement balance, you pay off $990 of it, and you have a 12% annual interest rate. After a month, how much do you owe in interest? I would have thought the answer was $0.10 (which is 1% of the $10 you didn’t pay). Apparently that’s not the case, and instead your interest charge would be $10. Yes, the amount you pay in interest could be 100% of the amount you didn’t pay in time after just one month.

What I wasn’t aware of is that if you don’t pay any portion of your credit card bill on time, you’re charged interest for the entire balance that statement period, and not just for the unpaid portion. I’m not sure there’s really any logic for that, but it seems to be the case consistently.

That’s another reason to be sure you always pay your full balance every month. However, I’m sure we’ve all at one point or another had a late payment. I know I have, either because I had something marked wrong in my calendar, I paid most of a balance but not the whole thing by mistake, etc. When that happens, often credit card companies will waive the late fee and interest charges if it’s your first “offense” just by calling and asking nicely.

Maybe everyone else in the world already knew this, though it came as a surprise to me.

Comments
  1. I’m rather astounded you didn’t know that.

    It’s also perfectly logical. You get an interest free period between your spend date and your payment date ONLY if you pay your statement in full. If you do not pay your statement in full then the interest free period is taken away – hence why you’re charged interest on the whole lot.

  2. Yup. If you have a $1000 balance, your due date is the 20th of the month and your statement close date is the 23rd. If you only pay $900 of that balance on the 20th and then the rest on say the 21st, or anytime before the statement closes. You’ll be charged interest on the $100.

    I noticed this with one of my cards a while back. I paid a portion before my due date, and then paid the rest off before the closing date for the sake of my utilization reporting. Was charged interest on my balance after the due date had passed.

  3. “I’m not sure there’s really any logic for that, but it seems to be the case consistently.”

    Welcome to the best democracy money can buy. Banking reform stymied repeatedly by politicians who are bankrolled by big banks so they can charge usurious interest rates. Some credit charges also charge a minimum monthly fee when you carry a balance, which I never do.

  4. @ Steven M you sound like a candidate for debit cards or cash. This entire blog is essentially about how to rip off banks… the fact that it’s a 2 way street surprises you?

  5. Didnt know this either. But Ive only been collecting points/miles for 4 years 😉
    Guess that’s the folly of never paying interest, ever!

  6. Like others, I’m amazed, gobsmacked, and dumbfounded that you weren’t aware of the way that credit card outfits charge interest on “unpaid balances,” but, sadly, I’m not really surprised. First, it’s something you’ve grown up with, and, second, you’re living within your means so you don’t ever see those horrendous credit charges on your bills.

    When my late father acquired a Diner’s Club card in the early 1950s, it wasn’t a “credit” card. Rather, it was a “charge” card, meaning the balance had to be paid in full every month. How times changed.

    This revelation is as if the caveman writer of a blog on the useful and lifestyle-enhancing uses of fire has suddenly learned that fire can burn you as well.

    While you’ve made general reminders from time to time on the dangers of credit cards, I hope going forward you’ll include more specific warnings. That would be a public service.

  7. “This revelation is as if the caveman writer of a blog on the useful and lifestyle-enhancing uses of fire has suddenly learned that fire can burn you as well.”

    Eh, wouldnt take it that far. Maybe some people just weren’t aware how hot the fire was.

  8. Ben,

    First off, very few if any credit card issuers will ever let you pay 10 cents in interest as there is a minimum finance charge which is typically $0.50 or $1.00. I have seen some issuers go as high as $2.00. With minimum finances charges just like the name suggests if the amount of interest you owe is less than the minimum finance charge the credit card issuer will charge you the minimum finance charge.

    Second, most credit card companies use the average daily balance formula to calculate your interest rate. What this means is quite simply that if you credit card closes on September 23 and you don’t pay off the last statement’s balance in full by its due date which lets say is October 18 then the bank will start charging interest on your balance from September 23 using the average daily balance. Lets use your example of $1000 owed on September 23 and you pay the card on October 18 then you would have an average balance of $1000 each day for the period times 25 days times 1% interest based on a 12% interest rate (overly simplified since it really is 12%/360 or 12%/365 depending on the terms of the card). This would leave approximately $8.22 in interest.

    Now all purchases you make on the charge will immediately accrue finance charges and you will begin paying interest on your interest charges as well. If you don’t use the card at all and work to pay the $10.00 balance off plus finance charges you will encounter trailing interest. Trailing interest is the finance charges accrued from your last statement until your balance is paid off but is only calculated by the credit card company on the statement closing date. That is why it is recommended to overpay your last credit card payment containing finance charges by $5 to $20 depending on your balance and the number of days since the closing date so that you can pay off this trailing interest. Otherwise the trailing interest can continue for several statements and often can be charged at the minimum finance rate.

    The best part is some banks don’t show their representatives trailing interest when you call in to pay off your credit card so even though you think you paid off your card you have not. Some CSRs will do the calculations manually to try and assist you but it really depends on your card issuer.

  9. Banks give us good stuff because they make money off of stupid people.

    Lucky you should use your blog to get more people in credit card debt so banks will make money and give some of it back to us as rewards.

  10. “While I think rewards credit cards are great for a majority of people……………..”

    The average household in the USA has over 13K USD in credit card debt. The savings rate overall in this country is -1%. Roughly 75% of Americans will carry a balance on their credit card for a year or longer just to pay for a single vacation. Hell, it appears that even Ben doesn’t take the time to read or understand his own credit card contracts. Yet he has no problem sitting there saving “rewards cards are great for a majority of people”.

    Let’s be honest……..80% of credit card holders are subsidizing this hobby for the other 20% of us. While I am slightly grateful that I can benefit from the financial irresponsibility of others, its clear that those people are in the minority. It is for this reason why I have a personal moral objection to referring friends or family members to credit cards, or even frankly discussing the benefits with them.

  11. This is a well known fact! That is why I often may use short term loans from friends and family to pay off the remainder of my credit card statement and never leave any interest. You have to pay it in full!

  12. As JC states its the Average Daily Balance. I pay my cards every 2 weeks because should I need to leave a balance it lowers ADB thus less interest charge (except those damn minimums).

  13. I also got stiffed one time because I was using a 0% interest balance transfer offer for a large purchase, and an annual fee hit in the middle. Because the annual fee codes as a purchase, and they make you pay the balance transfer off first, I was charged interest on my annual fee. I got it refunded after complaining, but it just goes to show that even though a lot of us leverage credit cards for great earnings opportunities, the companies are not your friend.

  14. JC is right, but has one mistake. If you don’t pay in full, the Avg Daily Balance is calculated from the date of each purchase posting, not the date of the statement period closing.

  15. For some issuers you are charged interest on the average daily balance. So if you pay $990 on the day after the statement closes, you will be charged less than $10. But every issuer is different so you have to read the fine print.

    Another thing to be aware of is that for many issuers once you are paying interest, you keep paying interest — so in the example above, if you leave that $10 balance to roll over and spend $10,000 in the next month, you are paying interest starting from the day of purchase on all of that $10,000 in charges.

  16. Another thing to watch: interest charges on spend when floating a balance transfer.

    A few months ago before selling a property, I closed out its mortgage by putting the balance on a separate home equity line. There was about a $4k remainder which I put on a 3% upfront, 0% 18 months interest “convenience” check from BofA through my Alaska Visa.

    While I could have paid off the $4k at the time, I never like parting with cash if it’s not necessary. Paying $120 to float $4k over a year and a half seemed like a good decision to me.

    While I rarely use the card for purchases, I do use it for food aboard, and to occasionally take advantage of their offers (usually net 5-10 bucks/mo with them). Overall, I might put 50-100 dollars if monthly spend on it.

    What I was somewhat surprised to see was that I was paying interest on my purchases while I floated the balance. Obviously it wasn’t a lot ($1.50 minimum charge) and was offset my my bonuses, but still.

    Here’s the big take away: if you pound a card with spend, NEVER EVER put a balance transfer on it. Put the transfer on a card in your sock drawer. Otherwise pull end up paying 23% apr on your monthly spend – even if you pay it off in full each month, thanks for the transfer balance.

  17. @Ben/Lucky,
    I am also in disbelief that you have only recently learnt about how interest is calculated on a credit card. :/

  18. @JC Get off your high horse pal. I’m a CPA that pays my bills off every month and I was surprised by this issue earlier in the year as well. Give him credit for being in this industry (and being supported by it) and still reminding people of issues like this. A lesser person wouldn’t say anything at all. This is a good blog and he has helped all of us travel more for less $$ out of our pockets.

  19. As a banker with Chase, who specializes in credit cards, I always tell my clients to make the credit card work for them, not you working for the credit card. Think of your credit card like a Debit card….once your purchase shows on your online or mobile app deduct it from your checking and pay the credit card this way you won’t end up with a balance on your card when your statement closes and you never have to worry about interest charges. This can be done daily, weekly, or bi-weekly. Get those rewards for free!!!

  20. Grant,

    Not sure why you would think I criticized Ben for posting this article. In fact, I am very happy Ben posted this article to share with others. I was simply trying to answer some additional questions that readers may not have been aware of and that other readers were asking in the comment section. Isn’t the purpose of the comments section to share information to assist others and have a dialogue? If Ben feels that my comment was offensive then he can moderate or edit it. If he doesn’t feel that my comments are welcome, then I will gladly stop sharing.

    JC

  21. Grant – You’re a Certified Accountant and you didn’t understand the fundamental basic of how credit card interest works!? Ben not understanding is fine as he doesn’t seem to pay it so it’s irrelevant to him, but an accountant!?

    Ben also doesn’t need any “credit” for sharing this revelation given it’s not going to make the slightest difference to anyone on this site when deciding whether to take it out or not.

  22. Thank you for sharing this Ben. I’m in the same boat — never was a problem so I never had to become aware of this…

    Someone mentioned that some credit cards don’t impose trailing interest on the first month — which cards are those? (Outside of the 0% introductory APR cards…)

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