A refresher for revolvers

Armed with some details about credit card debt, you can explain to the “revolvers” you know how interest is hurting them. Hopefully, this will encourage them to pay off their cards.

It’s the holiday season, and that means time with family and friends, parties, too much food and drink — and shopping. Which brings us, in an indirect way, to the issue of credit card debt. According to the Canadian Bankers Association, 60% of Canadians pay off their credit cards every month. But 40% don’t. These four in 10 Canadians, called revolvers, are financing gift-giving at their credit card interest rate. In many cases that rate is between 12.99% and 29.99%. So that $100 e-reader they just bought for their bestie cost $113 to $130 after one year, and more if they haven’t paid off their card by then.

If we dig into the details, it might encourage people to watch their spending this month and to pay off their cards.

If you pay your balance by the due date, you’re not charged any interest. The grace period to do this for most cards is 21 days after the statement date. (The interest-free grace period does not apply to cash advances.) If you don’t pay the balance in full, you will be charged interest. But how is it calculated?

The answer is in the cardholder agreement. According to a recent cardholder agreement, here is how Visa calculates it. It’s called the average daily balance method.

It takes any balance carried over from the previous month, adds the amount you put on the card each day and takes off any payments each day to get the balance on that day. It does this for each transaction category (purchases or cash advances). Then it adds all the daily balances and divides by the number of days in your statement period (usually 30 or 31). This is your average daily balance for the amount you owe in each transaction category. Then it multiplies the average daily balance by the daily interest rate for each category. This is the annual interest rate divided by 365 (366 in a leap year). It then multiplies the result by the number of days in the statement period. This total is the amount of interest it charges on the last day of your statement period. In this case, the credit card issuer is not charging interest on interest.

For example, let’s say you had $1,000 due on last month’s statement; you paid the $10 minimum payment on the due date 21 days after the statement date; and you made no purchases in the next statement period. You had a daily balance of $1,000 for 20 days and a balance of $990 for the remaining 11 days in a 31-day month. Your average daily balance is therefore $996.45.

Say your annual interest on purchases is 19.99%. Divide that by 365 and you get a daily rate of 0.0548%. The amount of interest charged to the end of the next 31-day statement period would be your average daily balance of $996.45 times the daily rate of 0.0548% times 31 days, and that comes to $16.93.

The problem is that revolvers buy more stuff, which increases the average daily balance. The result is more interest building up each month.

How your minimum payment is calculated depends on a number of factors, including your credit score. How that is calculated can be found in your credit card disclosure statement, which comes with your new card. In some cases it’s the greater of a percentage of the balance shown on the statement (often 2%), plus the greater of any amounts by which the new balance exceeds your credit limit or any amount past due from the prior month, or it can be a set minimum amount (often $10). If the new balance is less than $10, the amount due is the new balance. In other cases it’s the set minimum amount plus any interest and fees, plus any past due amount or any amount that exceeds your credit limit. Have you seen an “estimated time to pay” section on your statement? The regulators require credit card issuers to disclose approximately how long it will take to pay off the balance if you only make the minimum payments. The results can be disturbing, and I’m not sure the time quoted is always accurate.

For example, I’m looking at a credit card statement showing a balance owing of $7,168.51. The monthly minimum payment is $10. The statement says that it will take 57 years to pay off that balance. This assumes no items are added to the balance, but 57 years is 684 months, and 684 times $10 is only $6,840. That doesn’t cover the principal, let alone any interest that would be added. So it’s possible the repayment time period is even scarier.

Now you can explain exactly how interest is hurting the revolvers you know. Hopefully it will convince them that carrying a credit card balance is one of the worst things you can do for your personal financial situation.