The Hidden Fee for Paying Off A Credit Card (Hint: Residual Interest)
There are few things in life more painful than trying to decipher a credit card statement. Maybe things like going to the dentist would be more painful, but not by much. The problem is, if you don't understand the different things that might show up on your credit card statement, your finances and credit score can take a big hit.
I’ll save the conversation of why credit card statements are so confusing for a later time. For now, let’s talk about one of the hairiest and least obvious fees you might ever be charged: the fee that could show up after you pay off your credit card.
Why You Might Pay an Extra Fee After You Paid Off Your Credit Card
The first question coming to your mind right now is probably something like this:
How could I possibly get charged for paying off a credit card?
While the fee I’m referring to isn’t one that actually penalizes you for paying off your credit card, it is one that can pop up unexpectedly. In fact, you probably won't notice it until after your balance goes down to zero. That's why this particular fee can be so frustrating and if it goes unnoticed, dangerous. It’s called residual interest.
What Is Residual Interest
Residual interest is the interest charged when you don’t pay a credit card in full by the time the grace period is up. Not sure what that means? Let’s start with some definitions:
With credit cards, there’s a billing cycle, a closing date, a due date, and a grace period. Your billing cycle (the time between your bills) will vary based on your credit card. The last day of your billing cycle is the closing date, which is not the same as your due date. After your closing date, all of the new purchases you make go into the next billing cycle, even if you’re in the middle of a calendar month.
Your due date occurs somewhere around a month after your closing date (the date that ends your billing cycle). Some credit cards give you 25 days, some up to 30. You can review your credit card's statement to find out how much time there exactly in your billing cycle. In other words, you get approximately a month to pay off the balance before interest does its thing and increases it. This is called your grace period, or the time between your closing date and due date. If you don’t pay your balance in full by the end of the grace period (or by your due date), then you’ll be charged interest on the remaining balance.
What does this mean? It means you get approximately one month to pay off the balance before interest does its thing and increases it. This is called your grace period, or the time between your closing date and due date. If you don’t pay your balance in full by the end of the grace period (by your due date), then you’ll be charged interest on the remaining balance.
So what does residual interest have to do with this? A lot. Any balance that remains after your grace period is up is subject to interest charges - even if your balance is now at $0. Here’s an example to help explain why:
Let’s say that your billing cycle begins on the 15th every month and ends on the 14th of every month.
On June 15, you had a $700 balance carried over from the previous month. Then, you paid off the balance on June 25. You made no other purchases and no other transactions occur on your card after you paid off your balance. But, although you end up with a $0 balance on July 14, you still have to pay for the 10 days of interest on the $700 balance.
Sound crazy? Check out a credit card disclosure to see how many credit card issuers may characterize this:
Your due date is at least 25 days after the close of each billing cycle. We will not charge you interest on new purchases, provided you have paid your previous balance in full by the due date each month.
So any balance that remains after this 25-day grace period will be subject to interest until the day it is paid off.
Residual interest results when you start the billing cycle with a balance. If you had a $0 balance on June 15, but made $700 in new purchases and paid it off before the grace period ended, you would not face any interest charges.
You’ll stop seeing interest charges after keeping a $0 balance for two consecutive billing cycles.
As a rule, the best thing you can do after paying off your credit card is checking your credit card statement for two consecutive months. If you don’t see any residual interest by then, you’re good to go.
How to Avoid Residual Interest
The best way to avoid residual interest is to pay your balance in full every month. Since that option is sometimes easier said than done, here’s what else you can do:
Call your credit card company before you pay your card in full and ask for the full payoff amount. This amount may differ from what you might see on your statement as it may include that residual interest.
Even if you do this, be extra safe and check your statement for two consecutive months to be absolutely sure that the payoff amount you were told was correct. If the person you spoke to gave you the wrong amount and you were subsequently charged residual interest, you may be able to contest that charge. Just make sure you have the date and time of your call along with whom you spoke as confirmation of your full payoff balance request.
The Effect Residual Interest Can Have On Your Credit Score
A low balance, preferably less than 30% of your credit limit, is ideal if you want to maintain a good credit score. When you receive the monthly statement and discover that you still owe residual interest, the balance is usually low enough that there isn’t a significant impact on your credit score.
However, residual interest can turn out to be very harmful if you didn’t even know that it was there to begin with. It is possible that you believed you paid off your account balance in full and therefore wouldn't expect to owe any money. As a result, you likely wouldn't anticipate a credit card bill.
In that case, you could miss the payment due on your residual interest. That missed payment would then be recorded on your personal credit reports. That's negative mark and can lower your credit score.
Like with all things credit-related, it’s imperative to stay on top of payments, even if you think you’re already paid off. An unpaid bill - no matter the amount - can haunt your credit score. Always check future statements and bills, even if you don't anticipate owing any money.
Things to Think About Now that You’re Debt-Free
Residual interest isn’t the only thing to think about when you pay off a credit card. After you’re finished celebrating the incredible milestone of paying off your credit card, take a few minutes and make a plan for the next stage of your finances.
What stage is that? It’s the stage of financial growth. The stage in which you can ensure that you never go into credit card debt again and let your money start working for you (instead of the other way around).
No one wants to think about how credit card debt came into their lives - we’d all rather focus on how to get rid of it as quickly as possible and then pretend like it never happened. But the danger in that is ending right back up in credit card debt. And the second time sure is a lot more painful than the first time.
So, as you pay off your balance in full, take some time to evaluate what that means for your budget going forward. It’s going to seem almost like you had a pay increase at first since now you’ll have a set amount of money to do whatever you want with instead of having to push that towards your credit card. So, what can you do with that money?
Do you have other debt to pay off? You can boost that payoff by rolling your now paid off card’s monthly payment to your other debt accounts. Have a savings goal you’d really like to reach? Now you have a certain amount of money to put towards it - after all, you’re already used to living without that money. Not sure what you want to do? Allow your retirement savings to take the boost. That’s money that will grow even more over time - much more than it would in a regular checking account.
And, perhaps most importantly of all, make sure you consider how the credit card debt happened in the first place. Perhaps it was a slow uptick in your balance over time. Creating a more detailed budget can prevent that from happening again. Or perhaps it was one fell swoop, like an emergency expense. In that case, saving up specifically for an emergency fund could be a way to make sure you won’t need to use credit the next time.
Paying off credit card debt is an incredible accomplishment. It’s one to be proud of as you move forward in your financial journey. Just make sure you take stock before you completely move on - so your financial journey can be forever free of credit card debt from that time forward.