Because of the way banks and issuers calculate credit card interest, making more than one payment within the same billing cycle will help you pay off your debt faster: here’s the numbers
Credit card debt is a burden for many Americans. The high interest rates on these financial products eat away at consumers’ budgets, so it’s important to know a few tricks to pay off or reduce debt. And one that is very easy to carry out and that few do is to make more than one payment a month.
According to the New York Federal Reserve (Fed), the average annual percentage rate (APR) on credit cards is at its highest peak since 1994, at 23.4% APR in the United States.
Credit cards have a monthly billing cycle, which lasts between 28 and 31 days, where they tell you how much your debt is, what your minimum payment is and the cut-off date. When you make more than one payment a month, even if it only covers the minimum payment, it will help you reduce your debt faster. Even so, it is recommended that these extra payments exceed the minimum monthly payment to pay off your debt as soon as possible.
A credit card billing cycle does not necessarily end in the last days of the month. For example, an invoice could mark the 17th, 18th, 19th or 20th as the cut-off date, depending on the month.
How is your credit card interest calculated?
Depending on the bank issuing your credit card, although the annual percentage rate (APR) has an annual reference number, as its name indicates, interest is usually calculated on a monthly or daily basis. And when you consider that credit card interest rates are very high, your balance increases considerably day by day.
“Since interest accrues daily, not monthly, this means that if you don’t have a grace period (when a bank doesn’t charge interest), the faster you pay off your balance, the less interest you’ll pay,” explains the U.S. Consumer Financial Protection Bureau (CFPB).
For example, if your credit card issuer charges 20% APR, that means you will be charged a daily interest rate of 0.055%, divided by 365 days (20 ÷ 365 = 0.055). There are issuers that can calculate your daily interest by 360 days. In the same example, then there would be a daily interest of 0.056%.
If for the purposes of this explanation, we opt for the 365-day calculation, that means that each day your balance will increase by 0.055%. So, if you have a debt of $1,000 dollars, the next day you will have a balance due of $1,000.55 dollars (1,000 + [1,000 x 0.00055] = 1,000 + 0.55 = 1,000.55). But that does not mean that your balance will increase by $0.55 dollars per day, since interest is added on your balance, that is, your principal plus accrued interest, hence debts grow exponentially day by day, month by month, if not paid off soon.
So, on the second day of your debt, 0.055% interest will be applied to your balance of $1,000.55, which would leave an outstanding balance of $1,001.10 dollars (1,000.55 + [1,000.55 x 0.00055] = 1,000.55 + 0.55 = 1,001.10). By the third day, your debt would be $1,001.65; by the fourth day, $1,002.20; by the fifth day, $1,002.75; and so on.
Although in the first few days, it does appear that the increase is only $0.55 dollars per day, that would change on day 18, when your balance of $1,009.35 (from day 17) would have $0.56 dollars added to your balance, leaving it at a total of $1,009.91 dollars (1,009.35 + [1,009.35 x 0.00055] = 1,009.35 + 0.56 = 1,009.91). Here the important thing to understand is that the 0.055% per day will always be added to your balance, that is what does not change.
Why does making more than one payment in the same billing cycle help you pay off your credit card debt?
Regardless of whether your issuer calculates your interest on a daily or monthly basis, doubling your payments in the same billing cycle results in less interest-bearing balance the next day. You don’t have to be Einstein to understand that, if interest is calculated daily, when you make a double payment within your billing cycle, you help reduce the outstanding balance accruing interest.
And if with the double payment you exceed the minimum payment on your credit card, the benefit is greater, because for every payment you make, one third goes to pay interest and the rest goes to your balance.
To overcome compounding, which is the multiplier effect known as the application of interest on accrued interest, making an extra payment helps reduce the potential for compounding.
For example, if you have $2,000 in credit card debt that you cannot pay off before the end of the 30-day billing cycle, and you make a single payment of $200 on the last day of your closing date, you will have paid interest on an average daily balance of $1,993 in that billing cycle.
Now, if you were to make a $200 payment split over two days within the billing cycle, a $100 payment on the first day of your billing cycle and a $100 payment in the middle of your billing cycle, you will have paid interest on an average daily balance of $1,846 during that same billing cycle.
“Getting into the habit of making small payments throughout the month, rather than a once-a-month payment, could help you keep your balance a little lower. This can assure you (also) that you’ll make your minimum payment each month,” recommends Wells Fargo Bank.
Simply put, you’ll have paid less in interest, with the same monthly payment amount divided into at least two payments. If those extra payments within the same billing cycle were larger, you’d more quickly pay off your painful credit card debt.