I learned something new today and thought I would share my new found wisdom and frugality. Have you given much thought to the time of month you pay your credit card bill? Do you pay it around the due date? Do you pay it mid-month?
Why is this important? We think in monthly credit card cycles, but the bank thinks of your money every single day.
There’s a section on your credit card bill called the Average Daily Balance that determines how and when interest on your credit card balance accrues. In my bill’s tiny print section, there’s a heading called “Total Periodic Rate Finance Charge Computation.” Once you decode their language, you learn that finance charges accrue on a daily basis. The formula they use is to multiply your balance by the daily rate (your APR/365) and then multiply that by the number of days in that month’s billing cycle. This happens every day. Take what you owe today, add finance charges to it based on that formula–then tomorrow do the same thing all over again, except of course with a higher starting amount. Even if you aren’t adding to your balance by spending, the amount you owe goes up everyday through compound interest. Compound interest works in your favor when you are investing or saving, but it works against you if you are in debt.
One way to avoid paying interest on interest is to not carry a balance on your credit cards at all–with a so called “clean card” new purchases won’t accrue interest until after they spend a full billing cycle on the card, aka the grace period. I used to think you wouldn’t get interest added in on things purchased in the current month–that is wrong unless you aren’t carrying a balance. It turns out that if you have a balance on a card and you spend more money, the whole balance–old and new–gets the finance charge-no grace for you! You fall from grace, it seems, when you start to carry a balance on your credit cards. (I wonder why Dave Ramsey hasn’t jumped on that financial/theological doomsday message–if he hasn’t, maybe I’ll create an alias and write evangelical self-help finance books.)
We can’t all avoid carrying a balance forever, however, and I get that. Whether we are trying to pay down old debt or have a larger expense we need to split up over several months (or just overspent), there are times we end up carrying a balance.
Even with a balance carried over, if you simply switch the day that you make your payments to a day that’s earlier in the month, you reduce the amount of money you end up having to pay. Here’s an example (shamelessly borrowed from The Red Tape Chronicles) that illustrates my point: A full month’s interest on $3,000 at 29 percent is $74. Make the payment two weeks early and you’ll only owe $33.37 (that’s $40.63 less if you’re keeping score, and also a person with a way too high interest rate). That’s just one month–over time you pay off the debt faster and pay a lot less overall if you aren’t paying so much interest.
Even if you couldn’t pay the full amount due at once, you could send in partial payments during the month — perhaps half the money on the 15th, and then the rest on the 30th (that’s how many of us get paid as well). Using the same dollar amounts as in the first example, you’d owe $53 instead of $74 in interest–that’s $21 more money for you to keep. My guess is that it might take a few months for your cash flow situation and bill paying habits to adjust to needing the money earlier in the month to pay your credit card bill–but it seems well worth the effort.
It also turns out that if you are carrying a balance into a new month, the day that you buy things can also matter as much as when you pay the bill. Another borrowed example: two consumers with a $2,000 balance and a 29 percent interest rate make a $3,000 purchase during the month. One buys on the 5th, the other on the 27th. The first consumer pays $113.62 in interest; the second about half that: $61.18. In this case, it would benefit you to make a purchase towards the end of the month and pay your bill at the beginning of the next month.
Other things of note in the tiny print section:
- Your payments are allocated in whatever manner the company determines. In most instances, this means that if you transferred a balance to them to get a lower APR, your payment goes there first, leaving the higher interest debt sitting around to compound and compound and compound.
- The payment due date will not be the same every month (at least with my card). Sneaky little bastards.