Credit Card Interest for Newbs

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I like to think that I have a great sense of what's going on with my finances. As you have read in either this post about my financial goals or this post about my need for a new tracking system, I don't always spend wisely, but I ALWAYS know where my balances are at and when my due dates are. I keep my finances "in order", meaning they are orderly, but that doesn't mean I always make the smart financial choice.

A few months back, we had several unexpected life changes and for the first time, actually used credit the way it is intended - we charged the card and began chipping away at paying it back - but we did it completely by accident. I thought I understood how the whole interest thing worked - I mean, interest grows on the portion that you have not paid, right? Wrong. (at least for our cards)

So after seeing several interest charges and random fees on our statement, we went right to the customer service chat pod and started learning. Here's we figured out. 

I am in NO way a financial expert, a credit expert, or any type of expert on adult life. This is purely my small understanding of the basics. 

On your statement, it gives you two numbers - your current statement balance, and your total balance on the card.

  • Current statement balance – what you have spent in this “period” which is usually 30 days. This is what you have “accrued” during that period.
  • Total balance on the card – the above current statement and last period’s balance combined.

When you have a payment coming up, you are actually paying last period’s balance, which is conveniently not usually neatly calculated for you in the large numbers at the top of your online banking portal. In this way, whatever you spend in September won’t be due until November.

If you at some point miscalculate and don't pay off the entire previous month’s statement balance by the time the next statement is due, you are carrying a balance.

Pay off only a portion of what you paid in September by the November deadline = balance

Then, on your next statement, even if it is just a penny balance, even if you just mispaid by one cent, on your next statement balance, they will say "sorry, you carried a balance, and when we collect our interest on what you carry, we will be calculating from the entire statement - not just what you forgot to pay (or what you chose not to pay). 

Each credit card will charge a varying rate of interest depending on the company and your credit score. Typically, this rate will range from 15-30%, but at either end of the spectrum, you are paying a hefty amount.

If you carry ANY balance (even just one penny), you have to pay interest on the average for the entire balance during that pay period. If you maxed out a $10,000 card, and paid off the entire amount except one cent at the end of the pay period, they would charge interest on the average amount of your daily spending.

  • Average Daily Spending - the total spending amount divided by the number of days in the month

So, if you maxed out at $10,000, your total daily spending amount is probably around $300. And your 20% interest rate would be an unexpected fee of $60!

Now, hold onto this thought while I go into the next issue.

One good practice, when you don't have "solid" credit, (aka, almost anyone just starting out with this "adulthood" thing and wanting to build credit) is to pay attention to what "the man" calls credit utilization.

  • Credit Utilization - This is how much of your current credit limits you are using, combined from all of your current credit cards at the end of your payment cycle.

If you have two cards, and each one has a limit of $5,000, you have a credit limit of altogether $10,000. If you are using half of the limit on each card, you would have 50% credit utilization. The trouble with that, is that everything over 20% credit utilization is considered "bad." Any more than 20% and you are using too much of your credit.

The people who control the world want you to have a lot of credit (a large credit limit) but they don't want you to use it.

Their ideal customer will only use a small fraction of their credit limit. But, for normal humans in today's economy, that will hardly ever happen. The reality is, people are using a good portion of their credit limit, or they are spreading that credit limit over a number of cards. 

If you only have a couple of cards (aka most of you struggling "adults"), chances are, you use a significant portion of your limit every month. 

A good practice for us young folks with not a lot of credit (and a credit utilization score like that could really hurt your overall credit score) is paying off in spurts. When a paycheck comes in, you pay a $300, grandma sends you a birthday check, you pay $200, etc. So when your statement accrues at the end of your payment cycle, your credit usage is less than that 20% credit utilization – aka, pay it off chunk by chunk so your utilization percentage will be low, and your credit score will go up.

The problem with that though, is that pesky carry-over issue from up above. If you don't keep track of every cent appropriately, and pay off what you may think the remainder on the card is, you could be carrying a balance and then charged interest. Especially because most statements don't lay it out for you. They roll right into the next one, and you might have missed that late night McDonald's run on the last day of your pay period.

For example,

  • Your statement period is September 1st – 30th, and October 1st – October 31st.
  • You spent money in September
  • You pay off a $200 on October 9th
  • You pay off $175 on October 21st
  • You get your reminder to pay the rest of your balance on October 27th
  • You pay off what you think is left over from your September balance on October 31st
  • You get your paper or electronic statement with a breakdown of everything from September on November 7th and you were off by $1.35.
  • 'They' automatically charge you interest on the average daily usage from the month of September
  • You don’t notice the interest charge
  • November 30th comes around and you pay the ENTIRE balance from October
  • But you didn’t realize that the $1.35 from September was still considered on there.
  • 'They' automatically charge you interest on the average daily usage from the month of October
  • By the time you realize it, they have charged you $50 each month, for that $1.35 from September.

This is how they get you.

Few people carry cash anymore, and if you fall into this category, just be careful about your credit. In today’s world, I never carry cash. Never. Why would I when I get $20 or so in cash-back from my credit card usage every month?? 

But, you may think you're making all the right moves to maximize your small amount of credit, and a $1.35 coffee charge can quickly become worth a trip to Vegas. SO BE CAREFUL!

Let me know your experience with credit and interest in the comments or send me a message!