Why do my credit card finance charges make no sense?

November 6, 2008 6:38 PM

Is it just me, or is the way credit card finance charges are calculated not make any sense?

I recently found out that my credit card company applies finance charges in a way that strikes me as very weird, and I'd like to know if this is just the way it's done, or if my credit card company is different than most. Here's a scenario to describe the weirdness (sorry it's kind of long, I wanted to make sure I explain in full):

Lets call each calendar month a billing period for simplicity.

Say I have a balance of $1000 at the end of January, the first billing period of the card's existence. The due date for payment is the 15th of February, and on that day, I make a payment of $100 (this is greater than the minimum payment, so there are no late-fees involved).

Now lets say I had charged $1000 on the card on Feb 1, and didn't use it for the rest of February. So I have a balance of $1900 at the end of Feb, which I pay in full on the due date of March 15.

What I would logically expect to happen is this: I am charged interest on the $900 I didn't pay off by the Feb 15 due date. Since I paid it a month later on March 15, I should be charged a month's worth of interest, or the APR / 12 (or however the card company calculates the monthly interest rate, this is of no consequence). I would probably expect to find the charge for this on my March statement. Since I paid for the $1000 I racked up in February on time, I would not expect to be charged any interest on that.

What really happens is this: The fact that I didn't pay the full amount of my end-January balance by Feb 15 acts as a "trigger" for them to start applying finance charges, but the charges are in no way related to the actual amount I owe which is past due. Instead, they are related to my average daily balance from that point on. So, under the above scenario, my average daily balance for February would be $1950, and I'd be charged the monthly interest rate times $1950 in February.

To me, thats already illogical, because I'm being charged interest immediately on purchases as soon as they are made. But here's the really weird part: I'm STILL charged interest on any average daily balance in MARCH, even though I paid the full $1900, my balance at the end of february, by the due date of March 15. So if I charge $500 on March 1 and don't use the card for the rest of March, I'm actually charged the monthly interest rate times the average daily balance in March - which comes out to $2150 - at the end of March. If I pay THAT statement in full by the due date of April 15, ONLY THEN will they stop charging me interest.

So it seems that if I don't pay in full on time every month, I will start to be charged interest, unavoidably, for the next two months on my average daily balance. Even if I were to make a minimum payment and then pay in full the very next day, I'd still rack up interest for 2 months on my ADB.

Is it just me or is this completely illogical and a huge ripoff? Are there companies that don't do this?

posted by TSGlenn to work & money (11 comments total)

This is called Two Cycle Billing (link to cache b/c the original site seems to be down). Yes, it's a major ripoff, and every so often, there are proposals to make it illegal, but it's still around.

I am not sure about which providers use it, but I think both Chase and Citi do.
posted by bsdfish at 6:52 PM on November 6, 2008

It's just you.

This:

or however the card company calculates the monthly interest rate, this is of no consequence

...is wrong. They will calculate the interest due daily, and charge it at the end of the month/period. Even when you pay off the whole balance, you're still obliged to pay the accrued amount which won't've been on your statement. It'll've been sitting in a hidden 'accruals' account somewhere, on their side.
posted by pompomtom at 7:14 PM on November 6, 2008

American Express also does this with their non-charge-cards (e.g. Blue), although they call it a "purchase finance charge."
posted by subbes at 7:30 PM on November 6, 2008

because I'm being charged interest immediately on purchases as soon as they are made.

This is the way it's always been on all credit cards AFAIK. I'm not sure what logic you're applying but the deal is you only avoid interest by paying off the balance. If you're carrying a balance, you start paying interest immediately on new payments. There are an infinite number of ways they could choose to decide when and how to charge interest and this is the one they chose -- the only thing that makes one more logical than the other is this way makes them more money than what you expected.

I'm STILL charged interest on any average daily balance in MARCH, even though I paid the full $1900, my balance at the end of february

This used to be the case mainly on cards for subprime borrowers but over the past year many (most?) other cards have started to do this too. Again, there are any number of ways they could have chosen to determine the price their services and this is the one they chose. It's definitely annoying, even counter-intuitive, but not illogical.

So it seems that if I don't pay in full on time every month, I will start to be charged interest, unavoidably, for the next two months on my average daily balance.

Yes. That seems to be the standard these days.

Are there companies that don't do this?

If there are, they might well start doing it soon as this seems to be the trend

The best approach is probably to get a line of credit from your bank, and use that when you need to carry a balance, always paying off the credit card every month.
posted by winston at 8:43 PM on November 6, 2008

If you're carrying a balance, you start paying interest immediately on new payments.

I meant on new purchases.
posted by winston at 8:44 PM on November 6, 2008

So it seems that if I don't pay in full on time every month, I will start to be charged interest, unavoidably, for the next two months on my average daily balance

Doctor, it hurts when I do this!

Don't do that, then.
posted by flabdablet at 9:11 PM on November 6, 2008

Ah, yes, you have discovered the world's most secret secret: credit card companies are out to hornswaggle, mislead, and otherwise confuse you out of as much money as they can get.

And they're good at it.

As flabdablet said, stop living off credit cards! And, yes, carrying even a small balance over to the next month is living off your card...

In this particular economic environment, I'd rank people who are not working as hard as possible to pay off their entire credit card debt "financially suicidal." We're in a recession; every single indicator & most commentators are gloomy if not dismal; it's time to stop spending money you don't have!

(The soapbox is now free, if anyone would like to use it.)
posted by IAmBroom at 9:20 PM on November 6, 2008

Logic is a system for deriving conclusions from premises. You do not say what the premises are that lead you to believe that your card's terms are "illogical." I assure you that these premises are mistaken.

Here is a premise that will conclude with terms such as the ones you discuss: credit card issuers will charge whatever the market will bear. Within that framework, such a system of finance charges is eminently logical.

No, not everyone does two-cycle billing. Find a card issuer that doesn't. It is a big ripoff—you are right about that.
posted by grouse at 10:18 PM on November 6, 2008

is this completely illogical and a huge ripoff?

From the credit card company´s point of view, it is completely logical for them to pull a huge ripoff.
posted by yohko at 10:47 PM on November 6, 2008

Ok - Pompomtom - what I meant was that it is of no consequence to this question I am asking. I already understand there are different ways of calculating a daily or monthly interest rate, so I wasn't asking about that specifically.

Unrelated:

This place often surprises me with how quickly assumptions are made about the people asking questions. I do not live off my credit cards, and I pay off the balance in full almost all months. I wasn't asking for financial advice, especially not given in a condescending way. E.g.: Flabdat, did you really add anything valuable to the conversation with that comment?
posted by TSGlenn at 3:53 AM on November 7, 2008

Yeah, I think I did. That comment wasn't intended to imply that you, personally, live off your credit cards or constitute financial advice for you, personally. It was intended to convey my absolute astonishment that anybody would be surprised to find a credit card company seizing an opportunity to gouge customers who do anything other than pay in full, on time.

See, credit card companies are in business to make money. The interest-free thing for on-time payment is not something they do out of the goodness of their hearts. They do it because their competition does it. And the only way they are going to make money is if their customers fail to take advantage of the interest-free credit obtained by paying the bills in full, on time. So the company wants to arrange things to make such failures as likely as possible. That's why they offer insanely high credit limits, and that's why their interest rate calculation methods are hard to understand.

Most people understand that they will be charged some interest for failing to pay in full, on time. It's in the credit card company's best interest to obfuscate the actual amount of interest that will be charged. Most people just look at the interest rate number in great big type in the middle of the glossy brochure and ignore all the fine print. So if a company can make the great big number look really good by wording the fine print to charge you the great big number twice for any deviation from in full, on time - why would they not do that? Most people won't even notice, and most people won't change providers even if they do notice.

This seems so transparently obvious to me that I'm astounded that anybody would think it's even a tiny bit illogical. And the point I hoped my "don't do that, then" comment would make is that all that fine print stuff is murky - quite deliberately murky - and is therefore not worth getting caught up in.

There really is no point shopping around for a credit card with a better Great Big Number or better fine print. They all do the free-money-for-on-time-payment thing, so just commit to doing that, and pick the card with the best ancillary bribes attached.
posted by flabdablet at 5:12 AM on November 7, 2008 [1 favorite]