After six months of packing my lunch, temptation-proofing my life and obsessively monitoring my bank account, I finally paid off my credit card balance.
I was so excited to make that last payment that I completely forgot I had auto-debits set up every two weeks. As a result, I accidentally paid twice as much as planned, leading to a negative $75 balance.
On Thursday, Bank of America agreed to credit the balance back to my checking account within a few days.
But this morning I'd been hit with a $0.35 finance charge. Thirty-five cents is basically nothing, but I was stumped.
How could I possibly pay interest on an account with a NEGATIVE balance?
First, I called the bank's customer service line and was given a headache-inducing spiel about billing cycles and balances, APRs and blah, blah, blah. I hung up after 15 minutes more perplexed than ever.
What he told me will change the way I pay down debt forever.
"Credit card companies charge interest every day,"not just once a month when it shows up on our bill. "They look at your balance at the end of each day and they multiply that balance with your APR, divided by 365 days to make it a daily APR. That's the interest you get for that day."
The reason customers rarely understand this is because all we see on our bill statement is one big finance charge, he added. But it's actually a cumulative tally of each day's interest charges. The average daily rate's often included in billing statements, but even then consumers might not know what it means.
Example: Let's say you're working on paying of your credit card, like I was. Your annual APR is 20%, which in your credit lender's books, would make your daily interest rate about .0005% on whatever balance you're carrying.
After making a bill payment, you've still got $100 left on your balance. On Day 1, the bank will start tacking that daily interest charge to your balance, bringing it to $100.05 in their books – even though you'll still see an even $100.
And get this: On Day 2, you'll get charged that same daily interest on your new $100.05 balance, not just the $100. That interest will continue to compound each day until you've paid down your balance.
There's an exception here and it applies to customers who pay their balance in full each moth. They enjoy something of a grace period when it comes to finance charges and don't accrue daily interest, Papadimitriou says. In that case, your strategy – and mine going forward – should be to keep your funds in your checking or savings account as long as possible before paying off a credit balance, so that money will still earn interest.
As soon as you let a balance carry over on another billing cycle, you'll lose the grace period privilege and have to earn it back by paying your balance in full two months in a row.The moral of the story
"If you're incurring finances charges – meaning you're carrying a revolving balance – then it's important that you don't wait until the due date to pay your bill," Papadimitriou said. "Pay as quickly as possible because each day that passes you're paying interest on your balance."See the 9 steps I took to get my personal finances back on track >
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