Cutting Credit Costs: Pay Credit Card Bills Early
Question
I'm confused. One source says I should be concerned about the annual percentage rate for my credit cards and another source recommends paying bills early in the billing cycle to save money. Which source is correct? Does it really matter when I pay my credit card bill as long as it's paid by the due date?
Answer
Unlike “one-size-fits-all" clothing, the best advice about credit cards really depends on many personal factors including how you use the card and your repayment habits. Both sources have some truth and useful points.
- If you carry a balance on your credit card, the lower the annual percentage rate (APR) of your card, the less you will pay in interest or finance charges during a given year. In short, if you never pay your bill in full and other features of several cards are the same, the one with the lowest interest rate will save you the most money over time.
- If you always carry a balance, making your monthly payment early in the billing cycle (even before the stated due date on the billing statement) will also save you money. Why? Because most credit card issuers use the average daily balance method to figure monthly interest or finance charges. If you make your monthly payment early in the billing cycle, you reduce the daily balance for more days in that cycle. This also reduces the total balance used to figure the average daily balance for that month. See examples below to see how paying early in the billing cycle reduces the monthly interest charges.
- If you pay your monthly bills in full each month by the due date, you will avoid all interest charges.
Example 1. Credit Card Charges and Interest when Monthly Payment Is Made Early in the Billing Cycle.
[previous balance (May) = $500, APR = 0.18%, and monthly interest rate = 1.5]
June
June 9 - $400 payment
June 17 - $30 prescription payment
June 25 - $300 furniture payment
| Date (a) | # of Days (b) | Current Balance (c) | Total Balance in Period (b) x (c) = (d) |
|---|---|---|---|
| June 1-8 | 8 | 500 | 8 x 500 = 4,000 |
| June 9-16 | 8 | 500-400 = 100 | 8 x 100 = 800 |
| June 17-24 | 8 | 100 + 30 = 130 | 8 x 130 = 1,040 |
| June 25-30 | 6 | 130 + 300 = 430 | 6 x 430 = 2,580 |
| Total Balance = $8,420 |
Average daily balance = total daily balances/number of days in billing cycle = $8,420/30 = $280.67
Interest charge = $280.67 x 0.015 = $4.21
Example 2. Credit Card Charges and Interest when Monthly Payment is Made Late in the Billing Cycle.
[previous balance (May) = $500, APR = 0.18%, and monthly interest rate = 1.5]
June
June 17 - $30 prescription payment
June 25 - $300 furniture payment
June 29 - $400 payment
| Date (a) | # of Days (b) | Current Balance (c) | Total Balance in Period (b) x (c) = (d) |
|---|---|---|---|
| June 1-16 | 16 | 500 | 16 x 500 = 8,000 |
| June 17-24 | 8 | 500 + 30 = 530 | 8 x 530 = 4,240 |
| June 25-28 | 4 | 530 + 300 = 830 | 4 x 830 = 3,320 |
| June 29-30 | 2 | 830 - 400 = 430 | 2 x 430 = 862 |
| Total Balance = $16,420 |
Average daily balance = total daily balances/number of days in billing cycle = $16,420/30 = $547.33
Interest charge = $547.33 x 0.015 = $8.21
Prepared by Cathy Faulcon Bowen, associate professor, Department of Agricultural and Extension Education.
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