End this credit card ‘quirk’

A change to the way interest is calculated could bring welcome savings

It’s hard to believe but, at one stage, some lenders would direct any additional repayments made on your home loan to pay off your accrued interest first rather than use it to knock down your balance. It may seem like a minor detail but because the interest is calculated on your daily balance and charged monthly in arrears, this sneaky process clearly favoured the lender.

Thankfully, as Canstar’s Steve Mickenbecker says, “most interest rate quirks have largely been eliminated”.

Still, the latest reform proposed by the Australian Bankers’ Association highlights the need to understand how interest is calculated, especially on credit cards.

The ABA has made a number of proposals toward better banking (see The Buzz, page 12). For credit cards, the one that stuck out for me was the proposal that customers pay interest only on what remains on a credit card, and not on the full amount of purchase if a loan is being paid down.

Paying interest only on what you owe seems to make complete sense. You’d think this would be common practice but not so. Bendigo Bank is an exception, currently charging in line with the proposal.

Assuming you made a $3000 purchase and managed to repay only $1000 during the interest-free period, Mickenbecker says you can expect to save around $21 in interest under the change (see breakout).

But the proposal has a narrow impact, applying only to customers who qualify for an interest-free period by fully repaying their card by the due date but then only part-pay the account in the ensuing period. “It doesn’t benefit customers who are carrying a longer debt,” says Mickenbecker. “The savings are a one-off and don’t apply to ongoing outstanding balances left on the card.”

And that’s an important point. When it comes to understanding how interest on credit card works, you need to first understand the interest-free period. While your card may offer you 45, 55 or up to 62 days interest free, this doesn’t mean you have up to 62, 55 or 44 days interest free on every purchase you make. The total comes about through the monthly billing process (generally 30 days), plus the time between the end of your monthly billing period and the due date, which is generally 25 days if you have, say, a 55-day interest-free card. So if you make a purchase later in the monthly billing cycle, you’ll have fewer interest-free days.

If you repay your balance in full by the due date, no interest will be charged to your card. If you don’t pay the closing balance in full, interest will be calculated from the day the purchase was made.

Mickenbecker says this isn’t surprising. “After all, this is the date when the debt has been incurred and is being funded by the bank.” He says only a handful of card issuers charge interest only from the date of statement. Again Bendigo is one of these.

As for whether this will change, I would say let’s not hold our breath. “It would require system changes for the majority of providers,” says Mickenbecker.

To help you make your payments on time, ensure the statement period starts a couple of days later than your payday to allow for weekends and public holidays. Some banks allow you to change your statement period to match your pay cycle. It’s worth asking your credit card issuer if it can do this.

If you find that you can’t repay your card during the interest-free period, you may be better off with a card that offers a low ongoing rate. Generally, these cards tend not to offer any interest-free period. Canstar’s website lists interest rates starting from 7.99%. You could save around $28 for every month that you have that $2000 debt hanging around.

Finance expert and author of The Great $20 Adventure, Money’s editor Effie Zahos, appears regularly on TV and radio. She started her career in banking.