Maybe you’ve just gotten your first credit card, or maybe you’ve had one for a while, but aren’t yet sure how to use it. Regardless, there are some important things you need to understand—particularly in the fine print.
According to this 2013 CARD Act report, a majority of consumers often misunderstand grace periods.
By understanding grace periods, you can avoid unnecessary interest charges, and exploit the billing cycle to get more time to pay off big-ticket items.
What are grace periods?
A grace period is the time between the end of a billing cycle (also known as a “statement date”) and the day your payment is due. During this time, no interest accrues to your outstanding balance—so long as you pay the balance off the balance in full by the due date. If you don’t, then the grace period no longer applies to the balance that remains or even to the balance you paid off.
The company is essentially extending you the benefit of the doubt, assuming you’ll pay your bill in full by the due date.
If you don’t meet both of those qualifications—say, you pay the bill on time, but not in full, or you pay it off in full, but not on time—then the nice interest-free vacation is over.
Grace periods are all or nothing—pay your balance, or interest accrues
Let’s say your billing cycle ends on February 26th, and your total balance is $250, and, to make it easy, let’s say that was for one purchase, on February 23rd. Your due date is March 18th. Your grace period is the 21 days between the two. If you pay off the full $250 by March 18th, then you’ll pay no interest on those purchases. Basically, the credit card company has given you a free loan.
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However, let’s say you pay only $80 on March 17th, opting to spend the rest of it on green beer. While this is certainly better than paying only the minimum amount due, it still means that you’re gonna be paying daily interest on the remaining $170 until you pay it off, in addition to the interest that accrued on that amount between February 23 and March 17th.
Oh, and you’ll still be charged for the interest that accrued between February 23rd and March 17th on the $80 you did pay off.
Basically, the grace period agreement is straightforward: you pay it off in full and on time, and they charge you no interest. If you don’t, then interest accrues as it normally would.
Paying off your balance won’t automatically reinstate your grace period
Once you fail to meet your side of the grace-period arrangement—that is, once you carry a balance—then the grace period doesn’t apply going forward. That means that, for the billing cycle that started on February 27th, your purchases start accruing interest immediately. No grace period—no matter if you pay the balance off in full by the due date.
It varies by credit card, but many of them require two months of on-time, in-full payments before they reinstate your grace period. So one bad month can haunt you for as long as it takes to pay that balance (and the balances that follow) off.
Moral of the story: Do everything you can to pay off your balance in full each month.
Exploit the billing cycle to double your grace period for big purchases
Let’s say, however, that you’ve got a major purchase you can’t put off. In the best of all possible worlds, you’d save up the money, but, as you know, we don’t live in the best of all possible worlds.
You can, however, give yourself a little extra time to scrounge up the cash by exploiting the timing of your billing cycle. Basically, by timing your purchase just right, you can more than double your grace period.
Going back to the dates from the example above—let’s say you dropped your iPhone into the toilet on February 25th. Despite the best efforts of a bunch of rice, the phone can’t be saved. You’ve got some money saved up, but not enough to fork over $600 for another phone.
If you wait until the 27th (the first day of your new billing cycle) to head to the mall and buy a new phone, then that large purchase won’t show up on the bill that’s due March 18th. Instead, it’ll show up on the next bill, and the due date for that one won’t be until 21 days after the end of the current billing cycle (the one that just started), which probably lasts 30 days.
So that gives you 50 days, or more than six weeks (and three paychecks), to come up with the money you need. If you put $200 away from each paycheck (even if it’s a struggle), then you’ll have the money you need when that bill comes due.
Grace periods aren’t required and don’t apply to all charges
Grace periods are a holdover from the days of charge accounts at local merchants. Rather than go through the tedious process of calculating daily interest by hand, shopkeepers would give customers until the end of the month to settle up their outstanding bills. If they hadn’t paid in full, interest would accrue on whatever remained. The practice eventually transferred to credit cards, and continues today out of custom.
Grace periods do not, however, apply to cash advances or convenience checks, which start accruing interest immediately (and often at a higher rate than purchases).
Some cards may also exclude balance transfers from the grace period, so check the terms of your card.
While the Credit Card Accountability Responsibility and Disclosure Act, or CARD Act, does not require credit cards to have grace periods, it does require the ones that do to make their grace periods at least 21 days. (Grace periods were once 30 days, but in recent years companies have increasingly shortened them.) And for cards that don’t have grace periods, the company has to mail the bill out at least 21 days before the due date.
The CARD Act also requires companies to make the payment due date the same day each month. A company cannot legally alter their grace period month to month, or shorten it to less than 21 days.
Understanding grace periods is essential to successfully managing consumer debt. By knowing your billing cycle, and the terms of your credit card, you can take advantage of the spending power credit cards provide without racking up unnecessary interest charges.
If you understand your grace period, you can use credit cards as short-term, interest-free loans, which can keep you from getting pulled into the vicious cycle of minimum payments.