Residual interest: What it is and how it works

You’ve been running a credit card balance for a few months, but finally, you have enough cash on hand to zero out the statement balance.

With great relief — and more than a little pride — you pay it off. Thank goodness you’re done with that debt.

But wait: Did you also pay the residual interest?

What is residual interest?

Residual interest is the interest that card issuers charge those carrying a credit card balance for the time period between when the issuer sent out your card statement to when it actually receives the payment. It’s also called trailing interest.

The federal Consumer Financial Protection Bureau investigated residual interest charges on credit cards in 2015 as part of its biennial credit card report to Congress.

“We recognized, based on our research, that there is some confusion about this so-called ‘ghost charge,’” said Wei Zhang, the bureau’s credit card program manager. “People wanted to know, ‘What is this? Why is it happening?’”

The bureau did not find issuers doing anything illegal. However, it did discover that many details were buried in the fine print of credit card agreements. Card owners were often unaware of or did not fully understand what happened if they failed to pay their bill in full or how interest on the balance was calculated.

How does residual interest work?

Generally, if you have a credit card with a grace period and you pay your entire statement balance in full and on time each month, you won’t have to worry about residual interest. The grace period is the time between the end of your credit card’s billing cycle and the date your payment is due. As long as your grace period applies, interest won’t immediately accumulate on your new purchases. Grace periods typically last 21 days or more.

If you carry a balance, though, you will owe residual interest for the days that pass between the statement closing date and the date your payment is actually received. However, you won’t see the charges in your current billing cycle.

For example, say you have a credit card with a billing cycle that closes on the 15th of every month. On March 15, your statement balance is $1,200. Your due date on the bill is April 14th. But when the date arrives, you can only afford to pay $900 — meaning you leave a balance of $300 on the credit card. That $300 starts accruing interest the very next day.

How much interest? It depends on your particular credit card. Let’s say for this example that your card charges an APR of 22 percent. To figure out the interest, which issuers calculate daily, divide the APR by the number of days in the year. So 22 percent divided by 365 means 0.0602 percent daily. Multiply this by your current $300 balance, and you get 18.06 cents. That’s the amount of interest you will be charged on the balance each day. By the time the next month’s due date rolls around, 30 days later, you will owe $5.41 in accrued interest.

This is where things get tricky. Maybe you decided to clean up your financial act. You’ve only charged $200 this month, and now you can afford to pay off both the new balance and the $300 from last month. Everything’s squared away, right? Nope, not so fast. You still owe that $5.41 accrued interest. And if you don’t notice it and neglect to pay it, it will continue to accrue interest.

Or, if you do pay the entire bill by sending a check in the mail, residual interest will continue to accrue on the balance between the time you mail the check and the time the bank receives it and cashes it. Remember, there is no more grace period once you enter the land of accruing interest.

“Because it accrues after the billing period closes, [residual interest] won’t appear on your current statement — meaning that this could be a surprise amount you discover in your next statement,” said Megumi Smisson, who discusses personal finance on her podcast Ms. Money Moves and her website, Money With Megumi. “Or, worst case, you think you’ve paid off your card, don’t check your next statement to make a payment and incur a late fee and potentially damage your credit.”

Do all cards charge residual interest?

Residual interest is a common credit card feature. Supposedly, there are banks that don’t charge it, though those are increasingly hard to find.

“I’m not saying it’s impossible, but … [scoring a credit card that doesn’t charge residual interest] is kind of like finding the pot of gold at the end of the rainbow with a unicorn standing next to it,” said Bruce McClary, senior vice president of membership and communications for the National Foundation for Credit Counseling in Washington, D.C.

There are many credit cards that offer 0% intro APRs on new purchases or balance transfers for a limited time. There’s no residual interest to worry about during the promotional period. But to find out how your card deals with leftover balances, look at the back of the statement. It’s unlikely that “residual interest” will appear in those words.

Instead, look for phrases like “finance charges may be assessed even if payment is received in full within the current billing cycle.” Other ways to get this information and discover what the APR is for your card include looking at your card’s terms and conditions, visiting your issuer’s website or calling your issuer.

How to avoid residual interest

There’s no reason to pay months’ of residual interest on a balance that can be paid off quickly. To avoid this, take the following suggestions into consideration:

• Pay your card in full each month. “The No. 1 rule, the best advice for avoiding residual interest altogether, is to pay off your purchases immediately,” McClary said.
• First timer? See if you can get a break. There’s no harm in calling your credit card issuer and asking if you can get an extension on your payment deadline so you can avoid late fees, finance charges and any residual interest on this one cycle. “You never know what you’ll get until you ask,” McClary said.
• If that’s not possible, check your balance and pay it online. The credit card issuer should provide real-time information on your remaining balance and any interest charges.
• Get confirmation from the card issuer. This is particularly important if you are paying your balance by mail, either from a paper statement or from what you see online. Interest on the balance continues to accrue until the moment the bank cashes your check. If the check is insufficient because it doesn’t include those extra few days of interest, interest will accrue on the unpaid balance. Instead, before you write the check, pick up the phone and ask the credit card issuer for the payoff balance. “That is the best, the most foolproof way to accurately know the balance that would pay off the account,” McClary said.

Bottom line

If you let a balance carry from one statement to the next, you won’t just have to pay off the balance on your statement. You may also owe residual interest that isn’t included in your current statement. Check your total online. Call the card issuer to double-check. You can also check your credit card agreement to find out about residual interest or minimum finance charges.

And after you’ve paid what you believe you owe, check again, just to be sure.

Don’t just think you’re off the hook for the next month, Zhang said. “In many cases, you are probably not off the hook. Make sure there are not any residual balances next month.”