Credit Card Trivia - Grace Periods & Billing Methods

(originally posted somewhere else in 2006)

You've probably all seen this phrase in your credit card agreement: Grace Period. But what does it mean? The implication is that there is some amount of time where the credit card company will do something, but I've found that many people don't know what exactly it IS that they do. It sounds nice, right? Must be a good thing. Right??

First of all, let's talk about what it doesn't mean. A grace period has nothing to do with how long you have before you must pay your bill. Zip. Completely unrelated. Your due date lays that out quite clearly.

Secondly, please understand that if you aren't paying your bill in full every month, the grace period probably doesn't mean much. Let's talk about that some more.

A lender that offers a "full" grace period (usually 20-25 days) is saying that no interest will be charged on new purchased in that period until the grace period is up. This applies regardless of whether or not you paid your bill in full the previous month. When the lender calculates the average daily outstanding balance, these new purchases will not be included. Good luck finding a card that offers a full grace period.

A "typical" grace period means that any new charges during that period will accrue interest starting on the day that you make the charge. Average daily balances for the purpose of interest calculations will include these new purchases unless you paid your previous period's balance in full by the due date. These grace periods are very common, and are good if you pay your balance in full every month. If you don't - completely worthless.

There are also cards that offer no grace period at all, so every new purchase every month has interest calculated immediately. Bad, but intuitively easy to grasp. If you aren't paying your bills in full every month and you have either a typical or no grace period card, you're essentially in an identical situation.

There is also another credit card company trick that affects your charges and your grace period. It's called the two-cycle billing method. This one's a little more confusing, but in essence what it means is that instead of just using the average daily balance for one period to make their interest calculations, they'll use two months. How does that affect you if you have a grace period? I'll try to explain.

Let's say you get have a card with a nice, pretty $0 balance on January 1. You have a 25 day grace period. On January 7th, you go buy a used car with your credit card (please, for goodness sake, don't do this - I'm just using it as an example for a high dollar amount ... although I did know a girl in college who did) for $5000. You will not have interest charged on that balance until Feb 1 because of the grace period. In a one cycle billing method, if you don't pay it off in February, you'll accrue interest beginning February 1.

Still with me? Good.

In a two-cycle method, if you don't pay it off at the beginning of February, the company will look at your average daily balance going back to January 1st and charge interest back to the January 7 date when you bought the car. When you get your March bill, you will essentially have two months worth of interest being charged.

So much for that grace period, eh?

Now, if you make the purchase on January 31st (the end of our hypothetical billing period), you're obviously going pay less, but still - the two cycle billing method is out there to help the card companies, not the consumer.

Obviously, the best situation would be to pay your balances off every month. Even if you can't, you should understand that usually, the "grace period" your card offers is moot.

Whew, that was kind of a tough one!