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Why interest charges remain after a card is 'paid off'

'Residual interest' can nab the unwary

By

To Her Credit
To Her Credit, Sally Herigstad
Sally Herigstad is a certified public accountant and the author of "Help! I Can't Pay My Bills: Surviving a Financial Crisis" (St. Martin's Press, 2006). She writes "To Her Credit," a weekly reader Q&A column about issues involving women, credit and debt, for CreditCards.com, and also wrote for MSN Money, Interest.com and Bankrate.com, and has guested on Martha Stewart Radio and other programs. See her website SallyHerigstad.com for more personal finance tips and free budgeting worksheets.
Ask Sally a question, or read her previous answers in the To Her Credit archive
Question for the CreditCards.com expert

Dear To Her Credit,
After I complete paying a credit card off, the company charges me interest the following month. How can I avoid paying this interest? -- Ann

Answer for the CreditCards.com expert

Dear Ann,
That last bill for interest after you pay off a card is called "residual interest," and I'm afraid the only thing you can do now is pay it.

Most of us believe if we pay the balance in full by the due date of the bill, we won't have to pay more interest. In most cases, that's correct.

However, if you didn't pay your balance in full last month, your bank may charge you interest up until the day they receive your payment. Then, even though you paid your balance from the last statement, that interest shows up on your next bill. Surprise!

Not all banks charge residual interest. To find out if your bank does, look on the back of your statement. The terms of your card probably do not say they charge "residual interest" in those terms, but if it says finance charges may be assessed "even if we receive payment in full in the current billing cycle," they do.

You can also call your bank and find out if it charges residual interest. However, the customer service representative who answers may not know. Be prepared to ask to speak to a manager if he sounds unclear.

Charging residual interest is perfectly legal. And unlike the "double-billing cycle" interest some companies used to charge before the Credit CARD Act of 2009 went into effect, residual interest charges actually make sense. Here's why.

If you've been carrying a balance, you have no grace period when you can borrow for free -- interest has been charged every day. So when your card issuer sends a statement, the "balance due" on the statement is the amount due on the day the bill is created. It takes time for the bill to reach you, it takes time for you to mail back your payment. All the while, interest is accumulating.

The formula most cards use to calculate interest is the average daily balance method, which, as its name suggests, charges you interest each day you owe. You continued to owe money while the bill was being mailed back and forth, and the bank charges you for that time.

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?" Then just 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 make an online payment in 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. 

Of course, we'd all like to pay as little interest as possible. One way to avoid residual interest in the future is to choose credit card companies that don't charge it. (Be sure to take all factors into consideration when you choose a card.)

An even better way, of course, is to pay your balances in full every month before the due date. Residual interest rules don't apply if you paid the entire balance in full last month and this month.

Residual interest practices are just one more reason why credit cards are great payment tools, but they are not usually such great long-term loan tools. Now that you've worked hard to pay off this debt, you won't want to drag consumer debt forward from month to month ever again.

Congratulations on paying off a card, and keep taking care of your credit!        

See related: The ABCs of residual interest, What the new credit card law means for you

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Published: April 1, 2011


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