A reader writes in to ask why he’s being charged interest on his credit card’s purchase balance and a cash advance balance on the same card.
Typically, the purchase balance would carry a lower interest rate than the cash advance balance. However, that’s not always the case.
Reader Michael writes, “I took out a cash advance of $500 the other month. I paid down $1,000 of my credit card balance and the balance is $1,500 now. My understanding was that any balance paid over the minimum balance gets applied to the balance with the higher APR.
“However, the APR on both the balances are the same. The issue is that I’m currently getting charged interest on both the $1,500 and $500; seems like I’m getting charged interest on both balances. I believe the $500 is included in the $1,500 so I’m confused to how this makes any sense. Am I missing something here or is the bank actually double interest charging me by keeping the APR the same?”
Issuers place cash advances and purchases in different buckets
A cash advance on your credit card is different from a purchase you make.
You might tap into a cash advance in case you need money in a hurry. You can access it from an ATM. Or, the issuer may send you a check that you can use to pay someone else or even write a check to yourself to deposit in your bank account. You could also have had the issuer deposit the funds into your bank account.
Cash advances also typically carry a one-time transaction fee, in addition to the annual interest you pay. A purchase transaction is a transaction in which you make a purchase.
That’s why the two balances are listed separately on your credit card statement, along with a breakdown of the APR, or interest rate, that applies specifically to each type of balance, and the interest charged on each different balance for the period.
See related: Minimum payment formulas make a big difference in costs
Cash advances are charged separately from purchases
To calculate the interest on your purchase balance, issuers typically use what is called a daily periodic rate. To get this daily rate, divide your annual interest rate by 365.
Suppose your annual rate is 15%. Your daily periodic rate would be 0.041%. The issuer then applies this rate to your daily balance.
For each day of the billing cycle, the issuer figures out a daily balance, adding any purchase transactions for the day while deducting any payments and credits. The balance for each day is then charged the daily periodic rate and the amount is carried over to the next day’s daily balance (which means the interest is being compounded).
At the end of the billing cycle, adding up each day’s interest will give you the total amount of interest you pay for the cycle.
Issuers could also charge you interest based on your average daily balance by figuring out a balance for each day and then averaging it out for the cycle. The issuer would then apply the daily interest charges, multiplied by the number of days in the cycle, to this average balance to calculate the interest you pay for the cycle.
Issuers will also figure out an average balance for your cash advance feature, and charge you whatever monthly interest rate is applicable to that balance separately.
See related: How does credit card interest work?
Double cycle billing
In the bad old days before the CARD (Credit Card Accountability Responsibility and Disclosure) Act of 2009 went into effect, it was possible for issuers to engage in so-called “double cycle billing.”
With this practice, issuers could use an average balance that combined the previous cycle’s balance as well the current cycle’s balance. That meant even if you had paid off money in the last cycle, you could still be accruing interest in the current cycle based on an average combined balance. The CARD Act effectively banned double cycle billing.
See related: How to lower your credit card interest rate
How to avoid paying interest
Michael, you are right that the issuer should apply any payment that you make that is above your minimum payment due to the balance with the highest interest rate.
That, too, is thanks to the CARD Act. That way, consumers can pay off the highest rate balances faster. Since your APR is the same for your cash advance and purchases, it is up to the issuer to apply any excess payment to either of these balances.
However, you could take steps to save money on interest charges. For one, you could avoid carrying a purchase balance. If you have any spare money, pay off some portion of this balance.
Now that you know interest on your card balance is compounded daily, you can save some money by paying whenever you can, rather than waiting until you get your card statement. Until you pay off this balance, you will not get any grace period to avoid paying interest on your future purchases, too.
Here’s hoping you can pay off your balances soon and save on interest.