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How Two-Cycle Billing Works
By JLP | December 12, 2006
Be sure and BOOKMARK this for future reference!
Most credit cards use the single billing cycle when calculating your average daily balance. There’s a few cards out there (Discover is one of them) that use the two-cycle billing method when computing your average daily balance. What’s the difference? Let’s take a look and find out.
Single-Cycle Billing
Let’s say you have a credit card with no balance. You have just graduated from college and have a big interview coming up which is going to require a new suit (or dress). You haven’t the cash to pay for this suit so you charge it to your credit card with the plan to pay it back over the next few months. So, on July 10th, you charge $1,000 on your card that had a previous balance of $0. This is what your transaction log looks like:
You get the bill and see that your minimum payment is $20 and that it is due on August 26. You decide to pay $100 per month and you pay it on time. Your August transaction log looks like this:
How to calculate your average daily balance
Notice that the payment is made on the 26, which lowers your balance due by $100. Notice for the billing cycle that you had 27 days with a balance of $1,000.00 and 4 days with a balance of $900.00. As you can tell from this example, there are 31 days in the billing cycle. Your average daily balance is $987.10, which is calculated by adding up the balance for each day and dividing by the number of days in the billing cycle.
How to calculate your monthly interest charges (periodic interest charge)
Your APR on this card is 18.00%, which makes your periodic rate 0.04932% (18.00% ÷ 365 = 0.04932%). To calculate the periodic interest for the month of August, take the average daily balance × the number of days in the billing cycle × the periodic interest rate. It looks like this:
That $15.09 gets added to your balance so you start the month of September off by owing $915.09.
Two-Cycle Billing
With two-cycle billing, the credit card company uses two months to calculate the average daily balance. So, using the same numbers as above but adjusting them to reflect two-cycle billing, we get:
The month of August would look like this:
Based on this limited information, it looks like two-cycle billing is the better deal. It’s not, at least not in the long-run. Why? Because you are essentially paying interest on a balance you already paid off. Let’s go back to our example to see what I mean. Let’s say you continue paying $100 per month for the next few months and you don’t add any new charges. Then, in January you decide to pay off the balance on the card as follows:
Paying Off The Single-Cycle Card
Your final payment would have been $561.53. Now, depending on the credit card, you may be on the hook for any unpaid interest. In this case, we’ll assume the worst and say that you still owe an additional $7.48, which you will pay off the following month. This brings the total interest paid to $69.01 (July - January).
Paying Off The Two-Cycle Card
On the two-cycle card, your final payment would have been $561.43 and you would still owe an additional $8.60 in unpaid interest, bringing your total interest paid to $70.03 (a WHOLE $1.02 MORE than the single-cycle card).
So, although it doesn’t seem like that big of a difference, it can be significant if you carry a large balance. Two-cycle billing also hurts those who pay a lot off in one month but don’t extinguish the entire debt, leaving a balance for the next month. Naturally, if it’s bad for the card holder, it’s good for the credit card company.
It’s best not to carry a credit card balance at all. However, if that’s not possible, consider using a credit card that doesn’t utilize two-cycle billing (in other words, avoid Discover). Finally, avoid paying just the minimum payment.
Topics: Credit Cards, Financial Math Basics |
December 12th, 2006 at 7:11 pm
Are you sure that ALL discover cards do this? I’ve never noticed this before on mine. I’ll have to look into it.
December 12th, 2006 at 10:39 pm
Lawrence,
I’m not sure about ALL Discover Cards, but the two that my wife and I had used two-cycle billing. Although I searched Discover’s website, I could not find information on their other cards. They don’t really like to make that stuff easy to find.
December 13th, 2006 at 6:10 am
Hi JLP,
Thanks for this post, very interesting info. I have to say though, I’m nowhere near being a financial analyst, and I’m very perplexed by your xl examples. The July/Aug numbers look identical to me for both single and double-cycle, except for the totals at the bottom, and I have no idea how you came up with those. What two cycles does Discover use? Do they add August and a hypothetical September? Or August and July? Does that mean they wait an extra month at the beginning before they start billing you?
Also, could you give a quick example of how this problem scales with a higher balance? I know compounding makes interest payment (or debt) grow significantly over time, but say given a $10k balance paid off over 2 years, how much difference does this make?
Thanks!
December 13th, 2006 at 8:41 am
Foof,
I’ll figure something out.
December 14th, 2006 at 3:16 pm
Foof,
To get a rough idea of what it would be, multiply all the numbers by 10. Therefore, for a starting balance of 10k, in this example, interest would be $10. more, carry the same calculations further for a two year time span. Obviously, the larger the balance and the longer the pay-off time, the bigger the difference.
Regarding how the averaging works, one averages the daily balance over one month, the other over two, all with actual numbers, so obviously the first month the account is open either would look like a single cycle billing calculation. But as soon as there are two historical months on the account, the average daily balance is averaged over two months as opposed to one. Again, not a huge difference, but it is additive.
If anyone has a large balance they are carrying for a long time, they should look into a home-equity or other bank loan to reduce the interest charges.
December 16th, 2006 at 1:18 am
[...] All Financial Matters demystifies two-cycle billing. [...]
December 20th, 2006 at 9:06 pm
[...] We use the Discover Card, because out of the two cash rewards cards that we have, it has the highest rate of return and occasionally offers even higher percentages on staple items like groceries and gas. The one caveat is the two cycle billing (I would explain what this is, but JLP has aready done a marvelous job with that) that Discover utilizes. [...]
January 15th, 2007 at 6:02 pm
Thanks for the added info JLP. It makes a lot more sense now.
Another sneaky tactic my Discover card uses: They give a 1.5% APR on balance transfers for the life of the transfer, and encourage you to transfer a large amount. However, they then require you to make a $25.00 purchase every month, or you forfeit the rate.
The kicker is, purchases have an APR of 10-15%, and their policy is to apply all your credit card payments to the *lower* interest rate balance first, so you have to pay off the 1.5% balance transfer before you can even start making a dent on the monthly 15% purchases, which sit there and additively compound! Sneaky sneaky.
February 22nd, 2007 at 12:35 am
This information is not correct. You are assuming that Discover and the other issuers that use a two-cycle method (Chase, GE Capital, National City, and a few others) use a true two-cycle method, in which ADBs are always computed over two cycles, not just one. No one does this. What they actually do is to eliminate the grace period if you pay in full one month but revolve the next. In other words, with the exception of the first cycle, to get your grace period, you have to pay in full in two consecutive cycles. This really isn’t a true “two-cycle” method at all; it actually affects the grace period more than the balance calculation method. The disclosure ought to be that the balance computation method is single-cycle ADB and the grace period is provisional, but the Fed requires the disclosure to be two-cycle ADB with a regular grace period.
To see how this really works, let’s say that you get your new card with a 12% APR for Purchases, and in Cycle One you make $1,000 in purchases on Day 15. You get your bill for Cycle One, and there will be no finance charges, because you get a provisional grace period. Now let’s say you send in a payment for $800 on Day 15 of Cycle Two. On your bill for Cycle Two, you will pay $11 in finance charges. You will pay $6 in finance charges for Cycle Two ($600 ADB — $1000 for 15 days and $200 for 15 days — at 1% per month) and the $5 in finance charges for Cycle One ($500 ADB — $0 for 15 days and $1000 for 15 days — at 1% per month) on which you were provisionally granted a grace period. From that point on, if you revolve every month and never pay in full, your finance charge will be exactly the same under two-cycle ADB (the way issuers now impose it) as under single-cycle ADB. If you pay in full and then revolve again, there will one month where you’ll have to pay the previous month’s finance charge on which you provisionally got a grace period.
Hopefully that made sense.
February 27th, 2007 at 2:01 am
[...] So, today, what do I get in the mail? Bill #3, for $37, because they use the dreaded and sneaky (but apparently legal) two-cycle billing. (Click here for a really good explanation of how two-cycle billing works.) Which both of their previous customer service people the last two times I tried to pay the card off completely neglected to tell me. This time, once again, they assure me that I have the correct pay off balance. So wish me luck with bringing the balance down to 0 and having it stay there. I have little faith that it will. What sharks. [...]
June 30th, 2007 at 2:58 pm
I have a question for all you credit card wizbangs out there …
Recently, my husband and I received a very large sum of money and wish to pay off our two credit cards totaling $20K. The remaining funds will be carefully invested.
While we do have a 2 year old mortgage of $240K, we have no other debt. We own both of our cars, our student loans were paid off several years ago, and we have both been very aggressive with our retirement planning as well.
Our Chase card has a 3.99% rate until the balance of 11K is paid off, and our Citi card has a 8.99% rate on the 9K balance. To date, we’ve been paying $300-400 over the minimum every month on each card, but now, due to this recent blessing, wish to wipe it out in one big swoop.
Is there an optimal time in the cycle to pay off these balances in full, and if so, will doing this have any effect on our high FICOs? On one site, I read that you should pay off a balance in full over a period of a few months rather than in one lump sum?
Thanks for all of your great advice. We visit regularly.
August 31st, 2007 at 4:42 pm
[...] A Credit Card Crackdown - An interview with John Dugan, Comptroller of the Currency, about credit card companies. The interview mentions double-cycle billing. I wonder if credit card companies will do away with it? [...]
January 18th, 2008 at 1:29 pm
hey yeah i had a question. my gf got a new card and has a limit of 500 on it. she said she was going to keep all her reciepts and spend only 400 for a month. can you tell me how it would be on the statement.for instant like how much would it be for minium payment
March 4th, 2008 at 1:48 pm
I experienced this first-hand with Discover some years ago when one month I thought I had paid off the card (after carrying a balance over a few months) and the next month I get a bill for the add’l interest. Needless to say I’ve not used the card since.
July 28th, 2008 at 9:09 am
Another sneaky, and more obvious, trick credit card companies use is the fine print. We all know that all of this info is burried in a small booklet that usually comes with your first bill.
Americans on average read at an 8th grade level, According to a new study by the Fed. the credit card stipulations are written for a 12th grade level. This is more proof that the credit card companies want to slip in these “gotch’s” instead of disclose them.
July 30th, 2008 at 9:57 pm
[...] They couldn’t use the “two-cycle” method, which basically charges you interest on what you have already paid off. (Read How Two-Cycle Billing Works) [...]