Credit card interest is the worst. For one thing, most cards have APRs of nearly 17% on average, according to CreditCards.com. That’s compared to less than 4% for a mortgage or 11% on a personal loan.
When you use credit cards, you should aim to avoid paying interest whenever possible. Every time you open a credit card bill, check the line at the top that shows how much interest you have been charged. If this amount is not zero, figure out why you got charged interest so that it doesn’t happen again.
If you’re paying your full balance before the payment due date each month, that number should be zero. Here are some times when credit cards charge you interest.
1. When you pay late
Most cards offer a grace period, which means that a new purchase is not subject to interest until after the payment due date. The law requires interest-free grace periods to be at least 21 days. But the grace period applies only if you do not have a balance at the beginning of the billing period.
Let’s say you have a new card with no balance. You charge $100 on your card on July 1, the billing cycle closes on July 28, and payment is due on August 18. You have until August 18 to pay your $100 balance off in full without paying any interest. This means that in effect, you’re getting nearly two months of an interest-free loan.
However, if you forget to send your payment and it’s late, you’ll pay a late fee as well as interest on the balance, including on the late fee. While you might think that if you pay your balance two days after the due date, you’ll be charged two days’ interest, you will actually be charged much more than that. By paying late, you’ve lost your grace period retroactively, and interest is calculated starting July 1 — the day you made the purchase.
How much will you be charged? Credit cards disclose how they calculate the interest they’ll charge in those thin-papered, lengthy disclosures they send you, but in general, for every day that you have a balance during that month, you’ll owe that day’s balance multiplied by your daily periodic rate. You get your daily periodic rate by dividing your APR by 365. So the daily rate for a 20% APR is 0.054%. Depending on the card issuer, this rate may compound daily, meaning you will pay interest upon your interest each day.
You’ll see charges for this balance on next month’s bill. You started the new billing period with a balance, so you won’t have a grace period in the new billing cycle, either. At the end of the new month, you’ll pay for the interest on last month’s balance, which runs into the new month’s balance as well, plus interest on any new charges you make all month, and of course, a late fee for not paying on time. In addition, you may pay “trailing interest” the following month. More on that in a moment.
2. When you pay on time, but not the full balance
As we mentioned before, the grace period that cards offer only applies when you start the billing cycle with no balance. If you charged $1,000 last month, but only paid $900, you are starting the new billing cycle with a $100 balance. You might think that the bank would start charging interest only on the $100 balance that starts at the new billing period. But that’s not so.
As we saw in the example above, interest is charged retroactively if a purchase is not paid in full within the grace period. So you’ll be charged interest on the full $1,000 for the duration of last month’s billing cycle until the date the payment for the $900 was received by your issuer. At that point, your balance dropped to $100, and interest will then be calculated on that new balance until this month’s statement closes.
Want that grace period back? You’ll need to pay off the $100 balance plus the interest shown on your current month’s statement. But that’s not all. You may also be charged interest in the days between when the statement is issued and when your payment is received. This is sometimes called “trailing interest” or “residual interest,” and it’s most pronounced if you pay your bill with a check, which takes a few days to reach the issuer and clear.
For example, imagine you started February with that $100 balance. You receive a statement dated February 5 and send your check for the $100 plus interest on February 10. The issuer applies payment to your account on the 15th. Next month, you receive another statement saying you currently have a balance of $3.23. That’s the amount of the residual interest, which was charged to your account between February 5 and February 15. One way to avoid this is to use online payments, but even then you should call the bank and ask exactly how much you will owe if you make your online payment on February 5. Then pay that amount in full on February 5.
Unfortunately, even doing that is no guarantee. Some credit cards require you to have no revolving balance for two full billing cycles before you get your grace period back.
3. When a promotional 0% interest offer ends
There are a number of credit cards that offer a promotional period of 0% interest on your purchases. You won’t be charged any interest during the promotional period. But you will be charged interest on any new purchases as soon as the promotional period ends — and those interest rates can be high. That’s why it’s important to pay off the whole balance before the promotional period ends, and only use the card if you can pay off the full balance every month.
Also note that you can be charged interest if you pay late or violate some other part of the card’s terms and conditions. If you choose to take advantage of an offer like this, read every word of fine print to make sure you understand what you’re getting into. Check each month’s statement to check that you have not been charged any interest.
4. When you take out a cash advance
Your card agreement will lay this out: Your grace period usually does not apply to cash advances. Interest will start accruing the day you get the advance. Not only that, but cash advances often charge a higher interest rate than purchases and may come with a fee as well.
5. When you use a convenience check
Those paper checks that your credit card mails you are basically like low-tech cash advances, with the same disadvantages: Interest starts accruing the moment the check is deposited, probably at a higher rate than your regular rate, and there may be fees. When I get these, I immediately shred them.
6. When you charge a lottery ticket
I was surprised to find this warning in one of my credit card agreements: Purchases of “cash equivalents” such as lottery tickets, traveler’s checks, money orders, and gambling chips are not subject to the grace period. You may be charged interest on such purchases starting the day you make them, even if you don’t carry a balance.
7. When you transfer a balance from another card
Transferring a balance from a high rate card to a lower rate card can save you money, especially since many balance transfer cards offer 0% interest for a limited amount of time. But you should keep in mind that once you have transferred a balance to a card, you are carrying a balance until you pay it in full. That means that you will not have a grace period on that card.
That may not matter as long as you’re in the 0% promotional period and only have the transferred balance on the card. But as soon as you make a purchase on the card, it’s subject to interest from the moment you bought the item.
Not only that, but because of the way payments are allocated, it will take you longer to pay off the balance than if you’d put that purchase on a different card. According to the law, an issuer can apply the minimum payment amount to whichever balance it chooses (the 0% transferred balance or the higher-interest new purchase balance). The bank will no doubt choose to put that minimum payment toward the no-interest balance. Whatever you pay above the minimum must, by law, go to the higher-interest purchase balance. But if it’s not enough to clear the purchase balance, you’ll now accrue more interest charges on it next month. Bottom line: Don’t put new purchases on a balance transfer card.
And, as with the cards that offer 0% APR on new purchases for an introductory period, if you pay late or violate some other terms of the card, you could immediately lose your promotional rate and be subject to interest going forward. (See also: Your Comprehensive Checklist for a Successful Balance Transfer)
Beware the penalty APR
If you have multiple late payments, or if you write bad checks that the company has to return to you, your credit card company might slap you with a higher APR, which would apply to all future purchases, not just the late payment. Some cards will review your account and return your APR to your previous rate if you make consecutive on-time payments immediately for a certain amount of time.
Do you really have to pay?
Just because you see an interest charge on your credit card statement doesn’t mean you absolutely have to pay it. If you have a sterling — and long — history with this card company, they may be understanding if you slip up only occasionally. I have successfully had customer service agents waive both late fees and interest charges when I accidentally paid a few days late or even when I forgot a monthly payment altogether. On other occasions, customer service waived the fee but not the interest. It never hurts to ask.