Macro Mondays: Credit Cards (Part 6 of 10)
Welcome to another installment of Macro Mondays here on GradMoney! We continue onto week six of ten discussing the ins and outs of credit cards, and today we discuss the all important matter of making payments and understanding how one's interest is calculated. Additionally, in the off-chance that you absolutely must have a cash advance from your line of credit, we talk about how that is calculated and the impact that can have on what you owe to the credit card company.
It is always best pay your balance in full, if you can, but for millions of people that is not always the case and they must make gradual payments to pay off the full amount. But how are those payments calculated?
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The best way to use a credit card is to pay your bill in full and on time every month. You’ll avoid interest charges and late fees and preserve the grace period for new purchases. If you can’t pay in full, pay as much as you can. At the least, you should pay the minimum by the due date. You’ll incur interest charges, but you won’t damage your credit score by paying late, nor will you incur a late payment fee.
To understand exactly why you should try to avoid interest, let’s explain how credit card interest works.
How the Grace Period Works
The grace period is the time between when your credit card billing cycle ends and when your payment is due. It’s usually three weeks. Not all credit cards have a grace period; consult the terms and conditions of your credit card agreement to find out if your card does.
In fact, for purchases that you make at the beginning of your credit card’s billing cycle, your grace period will be considerably longer than three weeks.
You lose the grace period once you start carrying a balance. When you have a balance, not only does that balance accrue interest every day, but each new purchase you make does as well.
How Credit Card Interest Works
The interest rate your credit card charges is called the annual percentage rate, or APR. The average credit card interest rate was 13.08% as of the third quarter of 2017. Credit card interest rates can be as low as 0% for introductory offers if you have excellent credit. The cardholder agreement will show the range of APRs you might qualify for, such as 15.99% to 24.99%.
Your rate will depend on what card you apply for, your credit score and your repayment habits. For example, if you have excellent credit, you might qualify for a rate of about 10%, but if you go 60 days without making your minimum monthly payment, your rate might increase to 30% because of penalty repricing. (Some cards don’t have a penalty APR, however.) You can divide your APR by 365 to learn what your daily interest rate is. For example, an APR of 20% equates to a daily interest rate of .05479%.
When you carry a balance, interest compounds daily. Let’s say you start your billing cycle with a balance of $1,000 and a 20% APR. After day 1, you owe $0.55, and your new balance is $1,000.55. After day 2, your balance grows to $1,001.10. With no new purchases, after 30 days, your balance grows to $1,016.67. If you make new purchases, compound interest will pile up even faster.
Your credit card may have a fixed APR or a variable APR. If the APR is fixed, it will not change from month to month as long as you pay on time, and the CARD Act restrictions we discussed in section 3 will apply to any rate increases. The more common variable-rate APR credit card has a rate based on a market interest rate, such as the prime rate, which can go up or down as market conditions change. The card issuer adds a margin that’s based on your credit score to the prime rate to get your APR. The APR on a variable rate card can change without warning whenever the prime rate changes. But the margin cannot change without notice, as described in the CARD Act (see earlier posts). Check your card agreement to see how your APR is determined.
Remember, when you’re carrying a balance, the grace period doesn’t apply. So if you wait from the day your billing cycle ends until the due date to pay your bill, you’ll be accruing interest that entire time. This means that even if you pay your bill in full by the due date, you’ll still see finance charges on your next statement to cover the interest you accrued on both existing and new purchases between the time your billing cycle closed and the time you paid your bill. Thus, it really takes two full billing cycles and paying two consecutive bills in full for you to get rid of finance charges and get your grace period back. If you’re carrying a balance and you’re trying to end the cycle of paying interest on interest, try to pay your bill in full the same day your billing cycle ends. Waiting till the due date just means you rack up even more interest.
How Cash Advances Work
Cash advances work differently than purchases when it comes to interest. Regardless of whether you have a grace period for purchases, there is no grace period for cash advances. You’ll start paying interest on any cash advance from the moment you get the money. Cash advances also tend to have a higher interest rate than your purchase APR, and you may pay both credit card cash advance fees and ATM fees for taking them out.
Paying Your Credit Card Bill
Paying your credit card bill is a snap. If you receive paper statements, you’ll get a payment voucher and envelope that you can mail with your check each month. To avoid late fees and interest, make sure to send your check early so it arrives by the payment due date.
You can also pay online, whether you receive paper statements or electronic statements. Just go to your credit card issuer’s website or download the app and enroll your card to create an online account. You’ll then be able to pay your bill whenever you want through your computer, smartphone or tablet. If you bank online, you can use your bank’s online bill pay service to add your credit card issuer as a payee, then make payments that way.
The best way to ensure you never miss a payment deadline is to sign up for automatic payments, but you must make sure to review your credit card bill each month for accuracy and make sure your checking account always has enough to cover your bill. Don’t just set it and forget it.
Check with your issuer to see when payments will post to your account; payments you make on the due date may not post quickly enough to be considered timely, depending on what time you make them and what your card issuer’s time cutoff is. Be aware of time zone differences, too.
Next, we’ll talk about the cons of using a credit card.