Tuesday, October 27, 2009

How credit card interest charges accrue on a daily basis

By Todd Ossenfort

The Credit Guy
'The Credit Guy,' columnist Todd Ossenfort
The Credit Guy, Todd Ossenfort, is a credit expert and answers readers' questions about credit, counseling and debt issues.

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Question for the CreditCards.com expert

Dear Credit Guy,
If I make an additional huge payment to my credit card right after I make my scheduled payment, will a finance charge on the additional payment be made? Example: I owe $13,000. The scheduled payment is 300. A finance charge is taken, and a few days later, I make a payment of $10,000. Will a finance charge still be taken? -- Mr. Paul

Answer for the CreditCards.com expert

Dear Mr. Paul,
Your question aside for a moment, I definitely encourage you to go ahead and pay the $10,000 on your credit card account. In this economic environment, it is a good idea for everyone to pay off or significantly reduce large credit card balances.

To give you a specific answer to your question regarding how your extra payment of $10,000 will affect your finance charge or interest charges is not possible without reviewing your cardholder agreement. However, I can give you the general "101" on how many creditors apply payments and calculate interest charges on balances.

Most creditors assess interest or finance charges based on your average daily balance, and the interest is accrued daily. If you check your card member statement, it is likely that under the finance charges section of the statement there is a listing for the daily periodic rate -- reported as a percentage -- and a corresponding annual percentage rate.

Each day the balance of your account is multiplied by the daily periodic rate and the interest calculated is added to your balance. As an example, your $13,000 balance at a daily periodic rate of .02805 percent would add $3.6465 in finance or interest charges to your balance. The next day of the billing cycle your balance would be $13003.65 and multiplied by the daily periodic rate would add interest charges of $3.6475, which begins to add up. You begin to see how this works.

(Note to the math-challenged: Remember on percentages to add two zeros to the right of the decimal on the daily periodic rate when multiplying to get your finance charge. For example, multiply .0002805 by the balance to get your answer.)

At some point in the monthly billing cycle your payment is received. The payment is posted to your account based on the sometimes rather complicated rules included in your cardholder agreement. Typically, if you pay by check, the check must be received by 1 p.m. of a business day or it will not post until the next day. When making a payment online, the rules for when the payment is posted should be included in the transaction. For instance, it may include wording such as "this payment will appear on your statement 12 hours after it is received." Once payment is received, your balance goes down and along with it the interest you pay.

What many people do not understand regarding payments on credit card accounts is how the daily accumulation of interest affects your balance. For example, your $13,000 balance likely accrues almost $60 in interest charges before you make your monthly payment of $300. What that means is that what you thought was a $13,000 balance is actually $13,058 by the time your payment arrives. Your $300 is subtracted from the balance and your new balance is $12,758 -- not the $12,700 that most people believe it to be.

So, if your account accrues interest daily, the sooner you make your extra $10,000 payment the better. A balance of $3,000 at a daily periodic rate of .02805 percent accrues $.84 in finance charges daily compared to $3.65 daily for your $13,000 balance. And of course if your daily periodic rate is higher than .02805 percent, you save even more.

Take care of your credit!