12/17/2013 5:45 PM ET|
Ins and outs of credit card grace periods
Read on for tips to maintain or regain the period when you can borrow for free.
If you use a credit card and don't know the ins and outs of the grace period, you risk taking an awkward financial pratfall.
Capitalizing on the grace period's break on interest charges can save the typical cardholder a couple hundred bucks a year. But the savings aren't automatic and, according to an October 2013 report (.pdf file) by the Consumer Financial Protection Bureau, it's "unclear whether consumers understand" the grace period's wily ways.
"It's basically an interest-free period, but only if you pay your balance by the due date," said Nessa Feddis, general counsel at the American Bankers Association.
What it is: The grace period is the window of time from the end of your billing cycle to the due date for that cycle. Paying your new balance in full by the due date triggers a break on interest on new purchases during the current billing cycle -- if you pay in full consistently. While the grace period is referred to as an interest free period, the break on interest extends to the dates that purchases are made and posted to your balance.
Wiping out your monthly balance sounds simple, but it can be tricky if you don't already make a habit of it. Regaining the benefits of the grace period after even one month of carrying a balance can be confusing. And there are exceptions and pitfalls to watch out for. Paying in full during the grace period doesn't give you a break on cash advances or convenience checks, which, unlike purchases, usually begin building up interest immediately. Some balance transfers may also be excluded from a grace period, depending on the terms of your card.
Grace period is a holdover
Credit cards aren't required to provide a grace period, but almost all of them do, with the typical period being at least 25 days -- the norm for major issuers. If your due date falls on a weekend, the deadline extends to the next business day. Cards that do provide a grace period are required to mail your bill at least 21 days before your payment due date, under the CARD Act.
"It's a holdover from the origins of credit cards," Feddis said. "People would make a purchase at the store (on credit), and stores would allow people to pay at the end of the month."
The local grocer probably didn't want to calculate interest with a pencil stub on a brown paper bag, any more than his customers wanted to pay it. These days, calculating a daily periodic rate is a breeze for computers, yet most card companies continue to offer a grace period "because people are accustomed to it," Feddis said.
If you currently struggle to make the minimum monthly payment on your cards, it will take some work on your budget to get to the point where you can pay in full and qualify for the grace period. About 18 percent of Americans pay the minimum due each month, according to an analysis by the credit bureau TransUnion. At the other end of the spectrum, 42 percent regularly pay their full balances, capturing the benefit of the grace period's "free" loan from their credit cards.
That leaves 40 percent in the middle who pay more than the minimum, but less than the full balance. Paying more than the minimum is never a bad idea -- it will always reduce your interest costs. But if your budget allows, paying enough to wipe out your monthly balance entirely will boost your savings quite a bit more.
The cost of carrying a balance
This is because carrying a balance of any size into the next billing cycle means there is no grace period on your purchases during that cycle. The card company will begin charging interest on your purchases the day you make them. So leaving even $1 in unpaid balance on your card will cost you considerably more than the measly finance charges on that dollar.
To see how this works let's consider an imaginary card user named John. He's so happy he got a new credit card that he charges $1,500 in purchases on the first day of his monthly billing cycle. After the cycle ends, John pays off the entire $1,500 by the due date, wiping his balance to zero. As a result, his purchases during the second month are also free of interest. He has used his grace period wisely to avoid finance charges.
What happens if John leaves just $1 of his balance from the first month unpaid? That $1 begins to accrue interest starting the first day of the billing cycle. It's just $1, so the interest is not a big deal -- but because he used up his grace period without paying off his entire debt, his new purchases during the second month also start to get hit with interest charges immediately, starting the day of the transaction. Assuming he makes another $1,500 in purchases at the average annual interest rate of about 13 percent, that means $16 in finance charges for the month. If John repeats this pattern, the interest costs add up to $190 over the course of a year.
OK, $190 probably isn't going to delay John's retirement -- but why pay if it is avoidable? By just paying a little extra to wipe out his balance month to month, John would keep that $190 in his pocket.
Falling out of grace
Caution No. 1: If you have been carrying a balance, it may take two months of paying your balance in full to get off the interest treadmill. Some card agreements require two months of payment in full to reinstate the grace period.
"To get a grace period on purchases, you must pay the New Balance by the payment due date every billing cycle. If you do not, you will not get a grace period until you pay the New Balance for two billing cycles in a row," states a Citi card agreement template.
Caution No. 2: If you carry a balance, be aware that trailing interest, also called "residual interest," can build up on your balance before you have a chance to pay it off, even when paying the full balance shown on your statement.
To illustrate, say that John's billing period ends on Nov. 30, and his statement arrives in the mail about four days later showing a balance of $1,500 (made up of new purchases, old purchases and finance charges). Even if he pays the full $1,500 balance listed on the statement right away on Dec. 4, the interest built up during the four days it took him to pay the balance means that he'll have finance charges for those days -- about $2 worth, given his $1,500 balance. Taking a cash advance can also cause trailing interest, even if you paid your full balance the previous month, because daily interest will build up on the cash advance from the day you take it out.
The CFPB recommends you check your card agreement to understand how to reinstate the grace period. You might find language like this, from Capital One's Visa Signature card agreement:
"Interest charges accrue on every unpaid amount until it is paid in full. This means you may owe interest charges even if you pay the entire 'New Balance' one month, but did not do so for the previous month."
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Trailing interest tactics
Financial counselors say that with a little effort and enough ready funds, you may be able to make the jump to interest-free status in a single month. Joanne Kerstetter, vice president for education at Money Management International, recommends not waiting for your statement to arrive. If you go online and check your full balance on the last day of the billing cycle, and pay this amount immediately via online bank transfer, that will halt trailing interest charges from seeping over into the next billing cycle. Then if you resume paying your full balance by the due date on your next monthly statement, your grace period on purchases should be reinstated. It's a good idea to check with your card company to be sure this will work. Not all card agreements explicitly say that the break on interest resumes the month after you zero out your ending balance in this manner.
Trailing interest can be a sneaky pitfall if you aren't vigilant about your account. "Some people will pay the full balance and not check their next statement," Kerstetter said. People who think they've wiped their slate clean by paying off their full balance for a single month, and who don't check the next month's statement, might miss the few dollars of trailing interest. If that goes unpaid by the due date it can lead to late fees and, eventually, a demerit on your credit. "You have to realize that your next statement will reflect interest from the closing date," Kerstetter said.
Interest on disputed charges
What happens if you don't pay a charge by the due date because you are disputing it? Under the Fair Credit Billing Act, you can withhold payment on disputed charges while the creditor investigates without being charged interest. If you do, you take the chance of getting hit with interest on the disputed charge if your dispute falls flat. However, issuers say that the grace period on other purchases is safe -- it won't be affected by the disputed amount.
Many disputes are a slam dunk, such as mistaken double bills, or bills for unauthorized, undelivered merchandise. Frequently, however, disputed bills don't qualify for credit card charge-backs, Feddis said, such as when trying to return a product that you received but decided you don't want. "Some people say 'it's not the right color,'" she said. If the merchant's return policies don't entitle you to a refund, the charge could wind up back on your balance -- with interest. Your card may waive the finance charge on a disputed purchase if you are paying off your other purchases -- it doesn't hurt to ask -- but under the Fair Credit Billing Act, the lender is entitled to charge back interest on the disputed amount.
If the card won't waive the interest, you could pay the disputed charge provisionally, pending the outcome of the dispute, Feddis said. If the dispute is not clear cut, consider paying -- making sure to lodge your dispute first and indicate that your payment is provisional. It is better to wind up with a credit on your statement than to risk getting hit with back interest.
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