The ABCs of credit card residual interest

Paying your statement balance doesn't always mean you've paid in full

By Amy Buttell Crane

Credit card residual interest

When you pay the full amount on your credit card statement and don't add any new charges, your balance is zero, right? Not necessarily. Welcome to the world of residual interest -- where grace periods vanish and balances aren't exactly what they seem.

Residual interest, sometimes called trailing interest, accrues when your credit card issuer charges interest during the period between when your statement is issued and the date you pay your bill. That means that unless you call your credit card company and ask exactly how much it will cost to pay your bill in full on the date you expect your payment to arrive -- the so-called "final payoff amount" -- you will still owe interest on your next bill, even if you make no further purchases with your card.

This happens to consumers who keep a balance on their cards. If you pay off your balance at the end of each billing cycle, you won't pay any interest. However, if you fail to pay off your balance in a given month, that's when residual interest can rear its ugly head.

If you have been carrying a balance for two or more billing cycles, the so-called pay-in-full amount is not really a payoff amount, says Linda Sherry, the director of national priorities for community outreach and advocacy organization Consumer Action. If you pay in full, you will still have some interest left over. “Where it becomes an issue is when people think they’ve finished paying and so they don’t open the next bill and that can lead to late fees on a relatively small amount of money,” Sherry says. Late payments can also lead to an interest rate hike, which would make credit more expensive over the long-term, she adds.

Here's an example:

  • Say you've been paying down a balance for several months and your credit card statement, dated the first of the month, says that your balance is now just $1,000.
  • When you read that statement, you're excited because yofu know that you have $1,000 in savings that you can use to pay down that balance.
  • You send in your $1,000 check to the issuer on the fifth of the month, rejoicing in having finally paid off your credit card and hiding the card in a desk drawer.
  • The issuer applies the payment to your account on the 10th of the month.
  • Next month, you receive another statement saying that you currently hold a balance of $7.23.
  • That $7.23 is residual interest. In this example, it is the amount of interest that was charged to your account between the first of the month and the 10th.
Tips for avoiding residual interest

1. Make a phone call: Call your issuer's customer service number and ask them the following: "Assuming I make no more charges to this card, what will my balance be 15 days from now?" Pay that amount. Allowing 15 days will likely provide enough time for you to send the payment and the payment to be applied. You may end up paying a few cents too much, but it's better than underpaying and accruing more interest.

2.  Go online: Find out when your current billing cycle ends. Go online on the day the cycle ends, check your current balance and pay that amount. You may need to add a little bit extra to your payment if you're unsure as to whether your payment is applied immediately.

Even if you pay your credit card bills online you can be caught off guard by residual interest, Sherry says.  Cardholders who access their account online to make sure their full payment has been received by the due date would see a zero balance, because the trailing interest isn't added until the close of the subsequent billing cycle.

The ungraceful period
It's standard industry practice to charge interest on the entire amount owed -- including new purchases -- if a balance carries over into more than one billing cycle, says Norman Silber, a law professor at Hofstra Law School. However, many consumers still believe they have a grace period and are incurring additional interest charges because of that mistaken belief.

Sherry says it could be helpful to think of the concept in terms of other types of lending. When you take out a car loan or a mortgage, those loan companies will provide you with an amount you owe as well as your payoff balance as of a certain date. The difference between what you owe on the car on a given day and your ultimate payoff amount is residual interest.

Does your card company use it?
While credit card issuers explain how they calculate interest in a card’s terms and conditions, it’s a complicated topic and many cardholders still may not know how interest is applied, Sherry says.

To top it off, disclosures about residual interest have not been standardized and are not explained in an easy-to-understand way, according to Sherry.

An example of a residual interest disclosure by Capital One reads, “You may owe interest charges even if you pay the entire ‘New Balance’ one month, but did not do so for the previous month.”

The best way to avoid residual interest is to contact your credit card company prior to paying off the final balance, suggests Nessa Feddis, senior vice president at the American Bankers Association. Find out the amount you would owe on the day you plan to pay the card off and then pay that amount by that date.

See related: Common tricks and traps in credit card fine print, Why interest charges remain after a card is 'paid off'

Updated: June 17, 2016

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Updated: 10-27-2016

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