Reducing Credit Card Interest Expense
by Gary Foreman
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Is there any advantage to making more than one (even up to four) payments to my credit card company each month? I work at several housecleaning jobs for the sole purpose of paying off my credit card. I'm wondering if there would be any interest-savings benefit if I made partial payments at the end of each work week, rather than "saving up" the money for that payment which normally is made once a month.
Sherry's right. Sending in two or more payments a month will reduce her interest expense on most credit card accounts. But, before we see how much she'll save, let's look at how credit card companies calculate interest. The method they choose will make a difference in how much you owe and when you owe it.
The most common method is "average daily balance." Each day your account is credited with any payments received and any new charges are added. At the end of the month, the daily balances are averaged and that amount is multiplied by your interest rate to determine how much interest you owe for the month.
The "adjusted balance" method is skewed in the cardholder's favor. Any charges made during the billing period aren't counted until the end of the period. And if full payment is received before the end of the period, no interest is owed.
In the "two-cycle balance" method, two separate average balances are calculated. One is for the current month, and the second is for the prior billing period. They're combined to calculate the interest owed. Generally, this method leads to a higher balance.
While we're talking about credit card interest rates, let's spend a moment on "variable" and "fixed" rates. A variable loan will change weekly based on some published rate (like the prime rate). A fixed rate is only fixed until the credit card company tells you they're changing it. All they need is to give you written notice and 15 days warning. Like your mortgage, a variable rate is best when rates are going down. A fixed rate is better when rates are headed up.
Sherry also will want to know if she's being charged a "tiered APR" on any of her cards. Cards often offer one low rate for balance transfers, but any new purchases are at a different, higher rate. Another tiered method charges one low rate for balances up to a specified limit. Balances over the limit are charged at a higher rate.
OK, so how much could Sherry save in interest expense? Let's walk through the math. If she sent a second payment in the middle of the month, she'd save 15 days worth of interest on the amount that was sent in early. Suppose that her interest rate was 14% and she was going to send in $50. If her annual rate is 14%, the rate for fifteen days is .57%. (.14/365 days x 15 days = .0057) Sherry would save $.28 in interest (.0057 x $50).
Sherry can do the calculation using her numbers, but in this example, the cost of postage to mail in the extra payment is greater than any savings. Plus she'd lose out on any interest (however small) that she might be earning in her checking account for the same amount of time. Not very encouraging.
But that doesn't mean that Sherry can't do anything to reduce her interest expense. There are other strategies that could pay off for her.
One way to reduce interest expense is to call your credit card company and ask for a lower rate. They're not obligated to offer you better rates. But, if you've been a reliable customer, a simple phone call could save you money.
She should make sure that tiered accounts aren't bloating her interest expense. If so, she'll want to use a different card with a lower rate for new purchases or transfer a higher tier balance to a different lower rate card.
If Sherry has more than one card, she should pay off the one that's charging the highest rate first. If she only has one card, she might want to transfer the balance to a new card with a lower rate.
Also, prepayments make a big difference. If she were to add just $10 each month for a year at our 14% rate, she would reduce her interest expense by $29.50 during that year.
Bottom line? Sending in a payment in the middle of the month would reduce some interest expense because you're borrowing less money for a shorter period of time. But, unless you can afford to make a significant payment in the middle of the month, you'll probably save more money by using other techniques.
Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money and CreditCards.com. You can follow Gary on Twitter or visit Gary Foreman on Google+. Gary is also available for audio, video or print interviews. For more info see his media page.
Take the Next Step
- Make sure you're getting the lowest interest rate on your credit cards. You can compare rates here. Read carefully so that you know if you're getting an 'introductory rate' or if it's a 'fixed rate'.
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