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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 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.

"Residual interest is not an issue if you don't carry a balance, if you pay off your card in full every month," said Linda Sherry, the director of national priorities for Consumer Action, in a hearing held by the U.S. House of Representatives' Subcommittee on Financial Institutions and Consumer Credit in April. "However, 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. If you pay in full, you will still have some interest left over, and our concern is that consumers might not open a bill because they believe it's paid in full, and you could be hit with late fees and penalty rates, a drastic hike in your interest rate." 

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. 

Sherry called residual interest "an unfair and deceptive practice. 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 into a billing cycle, says Norman Silber, a law professor at Hofstra Law School. However, many consumers still believe they do have a grace period and are incurring additional interest charges because of that mistaken belief. Sherry believes credit card companies need to increase the types of information they disclose and the overall comprehensibility of their disclosures. Consumer Action and other consumer rights groups have suggested that the Federal Reserve require credit card companies to include information about a payoff amount in all credit card bills.

Peter Garuccio, a spokesman for the American Bankers' Association, notes that the ABA supports improved disclosures that would increase consumers' understanding of billing practices such as residual interest. "The association and the industry clearly supports improved disclosures," he says. "These disclosures currently have to be written in a way that complies with the regulations, but they can be hard to understand." 

"What consumers need to remember is that credit cards are a type of loan," he says. "And they are the only type of loan where if you don't carry a balance, interest is not charged from the time of the purchase until the payment is due, which can be as long as 45 days."

Sherry said 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?
Credit card companies are not required to disclose if they charge residual interest, Sherry says. However, many do let their customers know. To see if your credit card issuer charges residual interest, look at the credit card agreement or the back of your credit card bill. Language differs depending on the issuer, but if your card issuer charges residual interest, you will find language to that effect in the section entitled, "Calculation of Balances Subject to Finance Charges" or "Amounts Subject to Interest." 

A typical statement indicating that the issuer charges residual interest reads like this: "Finance charges will be assessed on previous purchase balances if your account was not paid in full in the previous business cycle, even if we receive payment in full in the current billing cycle," according to "Credit Card Pricing Developments and Their Disclosure," a discussion paper by Mark Furletti of the Federal Reserve Bank of Philadelphia. To date, disclosures about residual interest have not been standardized and are not explained in "a plain English way," Sherry says.

Consumer Action, a consumer rights group, found in a 2008 credit card survey and found that five of 22 credit card issuers surveyed charge residual interest, and the group believes that others do as well.

You can call your credit card company and ask, but the customer service representative may not be familiar with the practice, so you may not get a complete answer. If you don't, ask to speak to a manager. Before you get a new card, it's a good idea to ask credit card issuers if they charge residual interest, although it may be difficult to get through on the phone if you aren't a current cardholder.

Published: October 23, 2008



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