ELI5 Credit Card Interest
December 13, 2017 2:59 PM   Subscribe

Please explain credit card interest to me like I am five years old.

After years of financial instability, I'm finally adulting. I had a credit card that had an annual fee and just opened a credit card to earn frequent flyer miles on my preferred airline. I paid off the balance of first card last month in full. This month the annual fee was put on the statement as well as about $6 in "interest" charges. I didn't think I would get any charges since I paid the balance in full. I decided to cancel the card because I don't need a card with an annual fee and they waived the interest charge. I would like to use my new airline miles card as my sole means of purchasing power to accrue miles every month. How do I avoid interest? I know you pay your "balance" in full every month, but given the scenario of the other card I feel like "balance" is sketchy. Is it your statement balance? Or is it some weird combination of current balance at the time of a grace period window? How do I figure this out? If it is as easy as "statement balance" - why did I get charged interest on the other card?
posted by turtlefu to Work & Money (13 answers total) 2 users marked this as a favorite
I didn't think I would get any charges since I paid the balance in full.

You shouldn't have. I am going to outline this sort of overly wordily, but that is the short form.

Credit cards have due dates that are hard and fast, and also random, meaning they're often not at the end of a calendar month. They will be printed on your statement. Many credit cards will also let you set up ebills or autopay or other things that can ensure they get paid on or before the due date. And the due date is "We have to have the money by this date" not "You have to have mailed the check by this date" (I don't know how you paid the bill, but that could figure in)

And yes, as you saw, you can often get a freebie or two if you call to complain/cancel. There should be nothing sketchy going on here. Late fees and interest are weird, but at the end of the day they're just math, with the presumption that the company is also sort of trying to screw you, but they are heavily regulated. So to untangle this, I'd ask

- did you get a bill?
- was there a due date on it?
- did you pay well before the due date?
- did you ask the person you spoke with about this?

If you can offer more info about the type of card it is, people may have more specific experience.
posted by jessamyn at 3:13 PM on December 13, 2017 [2 favorites]

Did you by any chance take out a cash advance on the first (annual fee) card? I believe interest charges start accumulating immediately for cash advances, but should not do so for regular purchases. At least every credit card I have ever had, as long as you pay the full amount of your statement every month, you should never pay interest on purchases.

That said, it's possible different cards have different terms -- if you're seeing charges you don't expect, you can always call and talk to someone to figure out the situation. It's also possible your payment was a day or two late, or even that there was an error (since they did reverse the interest charges). Really, only talking to a rep from your credit card company can answer the question of exactly why you had the interest charges. But in general, if you pay off your bill on time every month, you should be fine.
posted by rainbowbrite at 3:14 PM on December 13, 2017

To answer the above questions, the due date on my statement was December 8th. I paid the balance in full on December 5th. I got my most recent statement today and decided to cancel the account. It was a capital one card. They had no problem waiving the interest but didn't explain to me why it was there (and I don't want to call them back.)
posted by turtlefu at 3:30 PM on December 13, 2017

Depending on how you paid your bill, it may have taken several days for your balance payment to travel from your account to theirs. There's no good reason for that of course, since data transmission over a wire is essentially at the speed of light, and since the server farms at your bank and at the credit card company can compute billions of transactions a second, but yeah. That's the excuse they make.
posted by turbid dahlia at 3:35 PM on December 13, 2017

If you had been carrying a balance on the account, interest accrues on a daily basis. When they print your statement, the balance reported would be the payoff amount if you paid it THAT DAY (not the due date, the day it was printed). They look at the amount and multiply it by your APR divided by 365, and keep tabs.

So what this means is that if they tell you that your balance due is $123.45, the next day a small additional amount of interest accrues, and then the next, and then the next, until they receive your payment. Then you pay off the $123.45, but in the meantime, some extra interest has accrued.

This sucks and is a little hard to wrap your head around.

If you pay off your bill every month, this does NOT happen, because there's a grace period where the credit card company is essentially lending you the money interest-free. That is generally the window of time from the time you make a charge to the time that the statement the charge is listed on becomes due. You don't pay interest on that money during that time, which is why credit cards can be a powerful tool if you use them carefully.

The basic rule to live by is that if you don't want to be paying interest, you have to pay the total amount due by the due date.
posted by jgreco at 3:46 PM on December 13, 2017 [4 favorites]

If you were previously carrying a balance, there was likely no grace period on interest charged to purchases and balances (check your card’s terms). When you paid off your balance last month, you paid the amount on your bill, but not the interest that had accrued in the period between the billing date and the date you paid.

Had you continued to hold the card, it is likely your bank would have restored the grace period next month (provided you continued to pay balances in full) (again, check terms), and you would have continued to enjoy the grace period on new purchases as long as you continued to pay balances every month.
posted by notyou at 5:13 PM on December 13, 2017 [6 favorites]

I think jgreco and notyou likely have it: if you had a balance on the card entering last month, likely you were being charged 'residual interest' (which is total BS by the way). This article on the ABCs of credit card residual interest spells it out in some more detail.
posted by crazy with stars at 5:27 PM on December 13, 2017

Did you do a partial early payment? They seem to treat that as the payment for the month and it triggers interest charges.
posted by TheAdamist at 5:43 PM on December 13, 2017

The other thing to be aware of with credit card providers is that they are very very selective about the order in which they settle the amounts owing when payments arrive.

If you give them any chance to classify an amount as not paid in full, they will take it.

So if you overlook some apparently minor issue like the exact date when an annual fee comes due, and just pay off the whole amount you've been lent in that month, they will take the annual fee out of your payment amount first - which then lets them treat the amount you've been lent as not having been paid back in full.

Even without annual fees, you really need to keep on top of every tiny charge they list on the bill. If your previous month is ever listed as not paid off in full, and you pay the current month in full (or so you believe), they will apply part of your payment to the previous month just so they can sock you for not paying the current month in full.

If you overpay them a little for the first few months, you should end up with a standing credit balance that buffers you against this kind of shenanigans to some extent.
posted by flabdablet at 6:29 PM on December 13, 2017

How do I avoid interest? I know you pay your "balance" in full every month, but given the scenario of the other card I feel like "balance" is sketchy. Is it your statement balance?

As other commenters said, it's difficult to figure out exactly where the interest came from in your particular situation without more info. Asking CapOne would be the most definitive and quickest--if you don't want to call them again, you could probably send an online message and ask for an explanation.

On the cards I have, there's no interest as long as I pay off the most recent statement balance (not the full "current" account balance) by the due date. I make the payments online and schedule them to process at least a few days before the due date so that there's time to fix things if something goes wrong.
posted by Sockin'inthefreeworld at 11:11 PM on December 13, 2017

Some companies, Chase being the biggest, use double cycle average daily balance to calculate interest. One side effect of this is that you will pay interest for an extra billing cycle since the metric used to calculate interest goes back to the beginning of the previous statement period.

For example, say you charge $100 on March 1st on a card with 19.99% interest and a 1.5% minimum payment. Later that month you get a bill with a minimum payment of $1.64, total balance of $100.00 and a due date of March 30th. (in reality it would be $10 because that's how they usually write the terms, but bear with me)

If you pay the full amount, we're all good and no interest accrues on most cards. If you only pay $10, things are different. Assuming no further charges, you are charged interest on the average daily balance for the current cycle and the most recent past billing period.

The difference isn't much if you calculate it as simple interest, but there is a small difference. (That's APR/365 * days in billing cycle * ending balance) The correct way is APR/365 * days in billing cycle * b, where b is your balance on each day of the past two billing periods added together, then divided by the number of days in those two billing periods. That means you're paying interest on $95 rather than $90 in the example, which is where the residual interest comes from.
posted by wierdo at 6:47 AM on December 14, 2017 [1 favorite]

Oh, and I have yet to see a credit card company that accrues interest daily. They typically charge the full amount on or near the closing date of the billing period. Only then does it begin to affect the ADB calculation, so as to compound monthly rather than daily.

They may exist, but even the scammiest scam cards I've seen don't do that.
posted by wierdo at 6:54 AM on December 14, 2017

Yup, that was residual interest. If you pay your balance in full (the amount due on your credit card statement) every month you won't have to pay a penny in interest.
posted by rabbitrabbit at 9:52 AM on December 14, 2017

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