Interest-Free Periods On Credit Cards: A Common Mistake

Interesting little article in the Press the other day which said that, because some card issuers had reduced their ‘interest free periods’, customers who habitually paid interest would be paying £3 million more in interest each year.

This demonstrates a lack of understanding of the basic financial drivers on card accounts, as a card issuer’s purpose for reducing the ‘interest-free period’ should relate to a desire to reduce the cost of funding those who pay in full, not as a means to raise more interest from those who revolve credit (i.e. not pay in full).

If issuers reduce the ‘interest-free period’ for full payers, it reduces the funding costs by paying off the outstanding balances earlier (assuming the account-holder changes their payment habits to the same degree).  This improves the issuer’s net interest income figures.

If issuers reduce the period for interest payers, their interest income actually reduces, assuming customers alter their payment habits to the same degree.  This is because they are effectively paying off an interest-bearing balance that bit sooner each month and thus reducing the balance on which the interest is earned.  An offset for the issuer is that funding levels also reduce, so the loss to the issuer is reduced (but not eliminated) by the reduced funding cost.  If you want to raise more money from revolvers, you extend the payment due date, beyond the statement date to as many days as your platform will allow…

If issuers are reducing interest-free periods (actually reducing the number of payment days from statement), then they are surely doing this only because the balance of outstandings has tilted more towards full payers, than revolvers, at the moment…