I often find myself answering this question. I recently found myself involved in a discussion and conversation with my own credit card company regarding an interest charge. It was only $13.00 but I wanted to get to the bottom of this huge misunderstanding and regular debate as a public service to my clients.
The following is an explanation and example courtesy of my Citibank card services representative.
When you agree to accept a credit card, you agree that you will pay back the amount you are borrowing for that month. [or “billing cycle”] in full or you will pay interest on the full amount regardless of how much you have paid [down or off]. It will continue to pay that interest until that amount is paid. If you use the card in the meantime, say next month [billing cycle] that will also be added and usually to the end. Therefore, you will not be able to pay that amount until you pay the previous amount.
Example: Jan has a credit card with a limit of $2000 and an interest rate of 22%. You load $2,000 onto that card during January. The bill comes at the end of the month, and you pay $1,000 of that bill. February will pay 22% of the total $2,000 because he said he would. He also agreed that he would pay 22% until that original amount is paid. If you didn’t use the card and paid the final $1,000 when your February statement arrived, you would be paying the $1,000 plus 22% interest on the $2,000. If during March if you still haven’t loaded more on the card, you would potentially have the interest on the $1,000 at 22% interest and you’re done.
What about balance transfers?
Tragically, most people don’t know this, nor do they understand that by loading more onto this card, the problem continues to fester and snowball. Therefore, the statement often comes up: “I should be fine because I switched mine to a ‘0%’ card for 1 year [or some other specific term]. That’s fine, however there are two additional traps that can [and do] significantly changes this ideal temporary recovery window. First, you may have to pay a fee, usually a percentage of the transferred balance. If it’s a large balance, this will equate to a large amount. Second, if you use this [new 0%] After you’ve transferred debt from another card, you’ll need to pay off the transferred balance before you begin paying any new charges you’ve added that are accruing at the card’s assessed rate after the “one year” period. zero interest period ends.
The following example is courtesy of one of my clients.
Example: Customer transferred $20,000 from a high interest credit card to a zero interest credit card for 12 months. He was short on cash one night and strictly and for convenience, he used this [new card] for the dinner bill of $70.00 dollars. After speaking with the card services representative. she was informed the following. In the agreement you signed for this [new] card, you agreed that the balance transfer amount would be assessed at 0% interest. However, if you use this card, the charges will “hunt to the bottom” or accumulate behind the $20,000 to pay off, so to speak. That is, the $20,000 has 0% interest, but the $70 you couldn’t pay until the $20,000 is paid, accumulates at 29% and will continue to do so until the initial $20,000 is paid in full. Only after this initial transfer was paid would the customer be able to pay the $70 plus interest at that time.
NOTE: “Billing Cycle [which is yet another way you can get hung up but we’ll address at another time].