Residual interest: what it is, how it works

You have a credit card balance for several months, but finally you have enough cash to clear your statement balance.

With great relief—and more than a little pride—you pay the price. Thank God you’re done with that debt.

But wait: did you also pay the residual interest?

What is residual interest?

Residual interest is the percentage that the card issuer charges from those with a credit card balance for the period of time between the time the issuer sent the card statement and the time the payment is actually received. This is also called moving interest.

The Federal Consumer Financial Protection Bureau investigated residual interest payments on credit cards in 2015 as part of its biennial credit card report to Congress.

“Based on our research, we realized that there is some confusion about the so-called ‘phantom payment,'” said Wei Zhang, the bureau’s credit card program manager. “People wanted to know, ‘What is this? Why is this happening?”

The Bureau did not find that the issuers committed any illegal acts. However, many details were found to be hidden in the fine print in credit card agreements. Cardholders often didn’t know or didn’t fully understand what happened if they didn’t pay their bill in full or how interest on the balance was calculated.

How long does the residual interest last?

After the end of the billing cycle, you will earn residual interest if you roll over the balance from month to month or miss a payment. So you won’t see charges in the current billing cycle.

For example, let’s say you have a credit card with a billing cycle that closes on the 15th of every month. As of March 15, your statement balance is $1,200. The payment due date is April 14th. But when the date comes, you can only afford to pay $900, meaning you leave a $300 credit card balance. That $300 begins to accrue interest the very next day.

How many percent? It depends on your specific credit card. Let’s assume for this example that your card charges 22% per annum. Divide the APR by the number of days in a year to find out the interest that issuers charge daily. So 22% divided by 365 means 0.0602% per day. Multiply that by your current balance of $300 and you get 18.06 cents. This is the amount of interest that you will accrue on the balance each day. By the time next month’s payment due date, 30 days from now, you will owe $5.41 in accrued interest.

This is where things get more complicated. Maybe you have decided to clean up your financial affairs. You have only withdrawn $200 this month and now you can afford to pay off both the new balance and $300 from last month. Everything is square, right? No, not so fast. You still owe the accrued interest of $5.41. And if you do not notice this and do not pay, interest will continue to accrue.

Or, if you pay the entire bill by mailing a check, residual interest will continue to accrue on the balance between the time you mail the check and the time the bank receives and cashes it. Keep in mind that once you enter an interest compounding country, there will no longer be a grace period.

“Since it is accrued after the end of the billing period, [residual interest] won’t show up on your current statement, meaning that this amount may surprise you on your next statement,” said Megumi Smisson, who discusses personal finance on her podcast Ms. Money Moves and on their Money With Megumi website. “Or, in the worst case scenario, you think you have paid off your card, not checking your next statement to make a payment, and taking on a late fee, potentially hurting your credit.”

Do all cards charge residual interest?

Residual interest is a common feature of a credit card. Supposedly there are banks that charge no fees, although they are getting harder to find.

“I’m not saying it’s impossible, but… [scoring a credit card that doesn’t charge residual interest] it’s like finding a pot of gold at the end of a rainbow with a unicorn next to it,” said Bruce McClary, senior vice president of membership and communications for the National Credit Counseling Foundation in Washington, DC.

There are many credit cards that offer 0% APR on new purchases and/or balance transfers for a limited time. To find out how your card is handling its balances, look at the back of your statement. It is unlikely that “residual interest” will appear in these words.

Instead, look for phrases such as “finance fees may be assessed even if payment is received in full during the current billing cycle.” Other ways to get this information and find out what APR is for your card include looking at your card’s terms and conditions, visit your issuer’s website, or call your issuer.

How to avoid residual interest

There is no reason to pay months of residual interest on a balance that can be paid off quickly. To avoid this, consider the following recommendations:

• Pay the card in full every month. “Rule #1, the best advice for avoiding residual interest altogether is to pay off your purchases immediately,” McClary said.
• First timer? Let’s see if you can take a break. There’s nothing wrong with calling your credit card issuer and asking if you can get a payment extension so you can avoid late fees, finance charges, and any residual interest for that one cycle. “You never know what you’ll get until you ask,” McClary said.
• If this is not possible, check your balance and pay online. The credit card issuer must provide real-time information about the balance of funds and any interest payments.
• Get confirmation from the card issuer. This is especially important if you pay your balance by mail, either from a paper statement or from what you see online. Interest continues to accrue on the balance until the bank cashes your check. If the check is insufficient because it does not include those extra few days of interest, interest will accrue on the unpaid balance. Instead, before writing a check, pick up the phone and ask your credit card issuer for the repayment balance. “It’s the best, most reliable way to know exactly what the balance will pay off,” McClary said.

bottom line

If you allow the balance to be carried over from one statement to another, you don’t have to simply pay off the balance on your statement. You may also have residual interest that is not included in your current statement. Check your total online. Call your card issuer to double check. You can also check your credit card agreement to find out about residual interest or minimum finance charges.

And after you’ve paid what you think you owe, check again just to be sure.

Don’t think you’re off the hook next month, Zhang said. “In many cases, you probably haven’t gotten off the hook. Make sure there are no leftovers next month.”

Constance Sommer is a freelance writer specializing in business, finance and healthcare. Her work has been featured in Forbes, Los Angeles Times, MarketWatch and Yahoo.