Everything You Didn’t Understand About Credit Card Interest, Grace Periods, and Penalty APRs
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One of the most important elements to consider when choosing a credit card is the interest rate or Annual Percentage Rate (APR). However, figuring out all the ins and outs of how credit cards charge interest can be confusing. In order to get the most out of your credit card, especially if you like to keep track of rewards programs and cash back opportunities, it’s important to look at how your actions can affect the amount of interest you pay. When selecting a credit card, it’s more than just choosing the lowest APR or best rewards. Being aware of the aspects of credit card interest can mean more money in your pocket and less in interest payments.
Deferred Financing vs. Waived Interest
At first glance, it might seem you can’t go wrong with a card with a promotional 0% APR. However, knowing the difference between deferred financing and waived interest could end up being worth hundreds of dollars.
- Deferred interest is most likely the offer you come across directly from a store. For instance, you can currently take advantage of 0% deferred interest financing on Apple purchases for 6 months on purchases costing under $498. The interest accrues during the promo period, but you don’t pay the interest unless you haven’t paid off the balance by the end of the promotional period. Further, if any of your payments are late, you could also be billed all of the interest that accrued since you made the purchase. With deferred interest offers, you will be assessed all of the accrued interest if you don’t pay your balance in full by the end of the offer.
- Waived interest, on the other hand, is commonly offered by standard credit cards. If your credit card offers 0% interest that is waived, you are typically able to take advantage of the promotional period without accruing interest. If for some reason, you don’t pay your balance in full when the promotional period ends, you just start to pay interest on your balance according to the card’s APR at the moment.
When interest is deferred, interest is still accruing. If you don’t pay your balance in full, even if you just have $10 left on your balance, you get charged for all the interest during the period. But if the interest is waived, no interest gets calculated until the promotional period is over. Then interest will start being added based on the balance you have left.
In either event, it’s best to pay your balance off completely within the promotional period , but if there’s any chance at all that you won’t be able to pay your balance down during the designated period, it’s best to make sure your interest is waived rather than deferred. Check your credit card conditions and especially take note of terms such as “financing” and “deferred interest” if you aren’t sure.
The credit card’s grace period is typically the amount of time between the end of a billing cycle and your payment due date. According to the Consumer Financial Protection Bureau (CFPB) credit card issuers must ensure that your statements are mailed or delivered at least 21 days before their due date. In order to take advantage of the grace period, you need to pay the entire balance in full before the due date.
The grace period though, is surprisingly tricky to understand. The important detail to remember is that interest is charged retroactively if a purchase is not paid within its grace period. For example, you charge $1,000 on June 1. The statement closes on June 15, leaving you a 21 day grace period to pay that off. You make a payment on June 30 for $900. A reasonable person would assume that the bank would start charging interest on the $100 balance, starting at the new billing period. That is not the case.
You will get hit with interest on the entire $1,000 for the duration of that billing cycle (from June 1 to June 15). That interest will be immediately posted to your account. Then, interest is continued to be calculated at $1,000 until the date the payment was posted to your account (probably around 5/2). At 5/2, your balance dropped to $100, and interest will then be calculated on the new balance, until the statement closes.
Now, by leaving a balance on your account, you no longer get the grace period for new purchases. Because you have $100 on your balance, if you make another $500 purchase, the interest will start accruing on that $500 immediately.
In order to reinstate your grace period, you’ll need to pay off your balance before the statement closes (not when it closes and bills you), because interest accrues during the time the statement closes and your bill is due. If the new billing cycle starts with a zero balance, then the grace period will be reinstated.
On more note on grace periods: Grace periods generally only apply to purchases, which is one of the many reasons that cash advances and credit card checks can be expensive. Because there is no grace period for cash advances, you start paying interest on the transaction date, even if you pay the balance of the advance in full before your next billing cycle. Plus, the APR for cash advances is usually higher than the purchase APR – often well over 20%.
In addition to APRs, deferred financing, and grace periods, there is also a Penalty APR to consider when you use your credit card. Not all credit cards charge a Penalty APR, but if they do, it’s important to understand how it can affect your payments.
Penalty or default APRs vary and have changed according to the Card Act of 2009. For consumer credit cards, a penalty APR can result in an increase to your interest rate if you miss a payment, make a late payment, or exceed your credit limit. For the most part, it means a significantly higher interest rate (often double what you start with) on new purchases. However, if your payments become 60 days late, the penalty APR can apply to your existing balance as well. However, if you end up in this situation, you aren’t permanently stuck with the penalty APR. According to the Card Act, once your rate is increased the card issuer must reconsider the penalty APR in six months and in most instances your APR will return to the non-penalty APR after making the next six consecutive payments on time.
Keep an eye on your fees and don’t hesitate to call your credit card to ask for a fee to be waived or lowered if it was just a one time mistake and you’ve been a good customer.