How Credit Card Payments Work

Credit cards and credit card payments are often misunderstood and misused. In this article we will examine how they both work and dispel any misconceptions you might have.

Card issuers explain their methods for calculating finance charges or interest on the back of each statement. The most common method is "average daily balance." To calculate this balance, the issuer totals what you owed at the end of each day in the billing period, and then divides that amount by the number of days in the period. That reveals the average amount you owed at the end of a day during that period and determines the interest charged. One thing that happens is when you make a large purchase at the start of a billing period instead of at the end; you wind up paying more in interest. Your average daily balance will increase or rise even if there are no new purchases, because there are more days with the higher balance outweighing the days with the lower balance.

To make matters worse, many billing periods are not a month long. Often they do not start at the beginning of the month nor end at the end of the month. You could use the card at the end of a month and have it appear at the beginning of your next billing period. This increases the amount of interest on your purchase.

A grace period is available from some issuers. This is the time from the end of the billing cycle given to you to pay your bill (commonly somewhere between 20 or 25 days). This means that if you start the billing cycle with a zero balance and pay in full by the due date, you will not have to pay any interest. The moment you carry over a balance to the next billing period, the issuer will immediately charge interest on every purchase.

The payment due date is the date that you must make at least the minimum payment. If full payment arrives by this date, your purchases are interest free. This is the best way for you to leverage your buying power. Leveraging basically allows you to use money available to you that is not available in cash at no cost to you. In a previous article, I introduced the concept of leveraging. If a payment is late, the interest rate you pay will be dramatically higher. Also the base interest rate may increase due to the fact that you have become a credit risk. Often you can negotiate the late fees away but the higher rate may remain. Use caution and be on time with payments to avoid this from happening.

"Teaser" rates are offered to promote low introductory rates on many credit cards. When the introductory periods ends, the card issuer will automatically begin charging the higher interest rate on any balance you carry at the time. These rates can be a great way to pay down a balance by transferring the balance from a higher rate card. Be cautious not to open too many lines of credit. This will severely affect your credit scores. If you do transfer the balance of a higher interest rate card to a lower or zero rate card, be sure to pay the proper amount to pay that balance off in the timeframe that you have the zero or lower interest. If not, it will convert to a higher interest rate and you will once again be faced with the same situation you were trying to eliminate.

There are other points of caution regarding teaser rates. Often the teaser rate cards have a tiered system of interest rates. This means that there is an initial teaser rate, and then an additional rate if you charge new items on the card. The other caveat in this situation is that the monies you send in for payments only is credited to the zero or lower rate, while the new balances start to charge more and more interest. This can really balloon into a large payment over time. Ouch!

So what is one to do?

1. Be sure that you understand how your credit card works.
2. Ask questions before enrolling in any new teaser rate card.
3. Understand fully the terms and conditions of the new card and try to negotiate the best interest rate if you have a remaining balance.
4. Pay on time and pay at least the minimum due. By doing this you will stay in the good graces of the lender.
5. Obtain a credit card with no yearly fees.
6. Remember some credit card require minimum purchase amounts. Visa, American Express and Master Card do not require a minimum purchase; Discover does.
7. If you experience a problem with a credit card, call the card company first. Be persistent, speak to a manager and get names and extensions and someone that you can call back if necessary. If all else fails, you can call your state consumer protection office.

Credit can be used to your advantage. As I always say be careful using credit and stay out of debt!

Cindy Diccianni is a Registered Nurse, a Certified Senior Advisor (CSA), a Certified Long Term Consultant (CLTC), a Registered Investment Advisor and a Registered Representative with Leigh Baldwin & Company member NASD and SIPC. She is affiliated with Ortner, O'Brien & Ortner Advisory Group, Inc., Malvern PA. Her passion is assisting clients in creating financial freedom. You may contact her at Cindy@taxlegalfinancial.com.

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