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You’ve bought that big screen TV you’ve always wanted, or maybe you finally purchased the vacation package to Timbuktu. Either way, you charged it on your credit card. As you sit there watching the Super Bowl, or after you arrive home and unpack your suitcase, there it is.
The credit card statement.
It’s time to start paying it down. Is making small payments each month a good idea, or is it better to pay that balance in large chunks, or even in full each month? There are multiple factors at play, but here are the primary rules to keep in mind.
Payments: Bigger is better
Generally, it’s best to pay your balance in full because any outstanding balance will likely get assessed interest charges. It may be a low introductory rate, or it may be 22.99%. Regardless, that is your hard-earned money that you are now giving to the credit card company. That also means it’s that much less money you’ll have for that next vacation or to upgrade to the next big screen TV. Making monthly payments that are above the minimum help your credit score. In fact, you want to carry as little outstanding debt as you can, because carrying a balance does not build your credit score.
Still, you can pay off that credit card over several months. As long you know that the card will reach a zero balance sooner rather than later, that’s fine, too. Indeed, if you are making charges on a 0% introductory rate, then it’s actually better to pay a lower amount each month and let that balance ride for free.
Compounded interest adds up
However, there’s a little trick for those who are paying interest on outstanding balances. If you read the fine print in most credit card statements, you’ll see the credit card company charges you interest according to a “daily periodic rate.” The Consumer Financial Protection Bureau defines it thusly: “A daily periodic interest rate is calculated by dividing the annual percentage rate (APR) by either 360 or 365, depending on the card issuer … [This is] used to calculate interest by multiplying the rate by the amount owed at the end of each day. This amount is then added to the previous day’s balance, which means that interest is compounding on a daily basis.”
This is vital information. It literally means that every day counts as far as interest is concerned. So let’s say you have a 20% APR and a $10,000 balance. On the first day that interest begins to accrue, it accrues a total of (.20 / 360) x $10,000 = $5.55. Well, the next day, your balance is $10,005.55, which gets multiplied by (.20 / 360), so the interest for that day is $5.56. And so on and so on …
Quickness saves you money
If you made your payment on the due date like the statement tells you to do, you’ll get hit with 30 full days of interest, each compounding on top of the other. But if you instead make that payment as quickly as possible — well before the due date — you save interest every single day.
So let’s say you know you can pay $1,000 that month, but you’ll be able to make a $300 payment a week into the month, another $400 two weeks into the month, and $300 in the third week of the month. You’ll save interest over the course of the month, and each succeeding month that you repeat this process.