Wednesday, 25 May 2011

Understand the pitfalls of your credit card's Interest-free Period

by Rob d'Apice
Do you sometimes get interest charges on your credit card account when you think you shouldn't have? You may be falling into a common trap with your card's interest free period that's buried deep in the fine print.

Already bored? Well, mismanaging your interest free period could cost an average credit card user up to $70 every month.  That's a lot of cappuccinos.

What is an "Interest Free Period"?

It's the period in which purchases made from your credit card do not accrue any interest. It generally stretches from the day that the purchase was made to a set number of days after your monthly statement was issued (typically 10-15 days). It means that, if you pay off your monthly balance in full within the required window each month, you will never pay any interest on your purchases.

Like. But what's the catch?

It's simple: you don't always get an interest free period. This means you start racking up hefty interest charges from day 1 of your purchase. There are actually 3 completely different situations where the bank won't give you an interest free period, and it's important you know about all of them.

1. When you have an outstanding balance
It's very poorly understood by consumers, but it's the same with all cards: If you don't pay off your balance in full for a particular month, you will forfeit the interest free period for the following month.

Here's an example: Caroline spent $2,000 on her card last month, and had until 20 May to pay off the balance in full. Unfortunately, Caroline is addicted to poor quality drama and spent the week watching Offspring episodes back-to-back instead of paying her bills.  It's now 25 May.

Caroline can't stay mad at Offspring's delightful cast and crew for long

Caroline now has two problems:

  • First, her $2,000 debt is now accruing interest, costing her about $1.21 per day or about $36 in total if the debt runs for a whole month; and
  • Second, all her expenses this month now have no interest free period. If she spends another $2,000 this month on her card (assuming it's spread evenly over the month), this could amount to another $36 in interest charges. 

By forgetting to pay off her balance, Caroline could have cost herself up to $72 in just one month. Lesson: pay off your balance in full. You forgot? Pay it off right now anyway (that fixes problem 1), and put in any extra money to slip your balance into the black - this means new purchases will be 'instantly' paid off and won't accrue any interest. And make sure you pay off any remaining balance in full at the end of the month to avoid entering an interest charge spiral.

2. When you have a balance transfer
Did you dutifully obey the advice of Prosple Credit Card tip 3; that is, balance transferring your debts to minimise interest? Well, there's a big catch with balance transfers - don't spend anything on the balance transfer card when you get it. One big reason is that you don't get an interest free period when you have an oustanding balance transfer amount. That means you're instantly racking up interest on your brand spanking new card until you knock off the huge chunk of debt you wheeled over to it.

The second reason? It's about the debt-repayment order on a credit card, which is a blog-post in itself, but put simply: when you make a repayment to the balance transfer card, the bank will use your money to pay off the (very low interest) balance transfer amount in full before you can pay off any of the (very high interest, with zero interest free period) new purchases. Yes, it's unscrupulous. But now that you know, go ahead and be unscrupulous right back to them.

3. When you get a cash advance
Credit cards 101: don't get cash advances. Cash advances attract a higher interest rate. They often incur an instant fee over at least a few dollars, and sometimes much more. And, on top of that, they don't attract an interest free period.

How can I remember to pay?

Paying your bill off in full can be particularly difficult for us internet-o-philes, because the reminder of the monthly due date can be less obvious in your email inbox than in letter form.

We suggest putting aside 20 minutes each week to check in on your finances. This means checking your internet banking site to see if you have anything due, and processing any bills/payments/boring stuff that you need to get out of the way. A Sunday night often works well, or first thing monday morning to ease yourself back into the week.

Does this sound outrageously boring to you? You're thinking about it the wrong way. This 20 minutes per week is a small investment to stay on top of your money. Trust me, if you do it right, it's going to be the most lucrative 20 minutes of your week. More on this topic down the track.

What else could you do in those 20 minutes?

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