Wednesday, January 18, 2012

The Cost of Paying Bills Early

You’ve logged in to pay your credit card bill and you have to choose the date to transfer the money. Do you choose the actual due date, the day before, or some earlier date? What is the right balance between the risk of late fees and the opportunity cost of paying early?

Some people say they always pay bills on their due date and have never had a problem with late fees. Others claim that banks use dirty tricks like setting due dates on weekends and holidays and not recognizing payments until the following business day.

It can be difficult to gauge the risks of paying on or very close to a due date. But it isn’t too hard to figure out the cost of getting caught paying late if you can’t talk the bank or other creditor into waiving the late penalty. Many utility bills actually say explicitly what the cost will be if you pay late. With credit cards, the cost is retroactive interest back to the date of purchase on all outstanding items. The total penalties are often in the 2% to 3% range.

The opportunity cost of paying bills early depends on what else you would have done with extra money. It would not be a fair comparison to say that you are just losing bank account interest, unless you really just have all your savings in a bank account. If you had more money in your bank account, you’d probably use the excess for some other purpose such as paying down debt or investing for retirement.

I’ll use 8% per year as an opportunity cost on the assumption that this is a reasonable return expectation for retirement savings and that you’ll find some way to avoid paying higher than 8% interest on any debts.

On a $1000 bill, cost of paying late is about $20 to $30, and the opportunity cost of paying early is about ($1000 * 8% / 365) = 22 cents per day. In my household we tend to pay bills at least 2 days early, but occasionally as long as 2 weeks early for an average of about 3 days. On a yearly total of about $40,000 in bills, the total opportunity cost works out to $26 per year.

So, if this policy of paying early prevents just one instance of paying a $1000 bill late during the year, we’ve broken even. I’m no fan of giving money to banks needlessly, but I do like not worrying about whether our payments are made on time.


  1. I pay bills early these days. There is essentially zero interest to be earned by delaying a couple of weeks.

    However, I used to deliver payment one day prior to due date.

    BTW: I believe 8% per year is a very generous expectation.I truly hope you can earn it.

  2. @Mark: The point of my post was to actually work out the quantity you describe as "essentially zero interest". If we drop the investing expectation to 5%, but increase the number of days of paying early to 14, the cost for me would be $77 per year. I agree that this is low, but it is not quite zero. So, I can see the logic in getting reasonably close to the due date (say within a week), but I don't see any logic in trying to hit the date on the nose.

  3. I'm with you, I pay two business days early so I don't have to worry about late fees. I've been able to phone up and get late fees wave on the occasional mess up, but really don't like having to phone.

    8% opportunity cost wasn't so far off in the days that my home wasn't paid off. I used a secured line of credit, something like a Manulife ONE account these days. All paychecks went to pay down the credit line and bills were paid out of it as close as to the due date as possible. Every day I had an extra dollar paying down the line of credit saved 6 or 7% interest in after tax dollars. I guess interest rates are unusually low these days, but still avoiding the after tax cost of home loan interest is a sure thing and pretty hard to beat with any other investment.

  4. @Greg: I'm glad to hear that you were able to pay off your home. Some of the people I hear about who run all their finances through a single secured line of credit have difficulty paying it off because of the temptation of dipping into the LOC.

  5. @Potato: Statistically, things work out as I described, on average. However, for a particular bill, the cost of paying early does depend on its timing relative to when you get paid. Part of the reason for the exercise I went through in this post was to get a handle on the amount of money at stake. For me, it is low enough that I see little point in trying to optimize.

    1. The comment above is a reply to Potato's comment:

      In some situations though you couldn't have used the cash to invest. For instance, if I get paid on the 30th, and most of my bills are due around the 20th, whether I pay them when the mail arrives on the 5th or wait until the 19th, I'm still going to have nothing left in my chequing account for 10 days.

      If on the other hand I get paid on the 15th, with bills due on the 20th, then by paying later I could reduce the float in my chequing account compared to paying early. So I guess it only applies if you have money coming in at some point between the bill date and the due date.

      Though I suppose in the first case I could invest the amount of the bills at some rate of return, pay the bills closer to the deadline from a LoC, and then pay off the LoC when the next pay period arrives. Then I could get a full month of compounding out of the invested funds, but only pay interest for 11-12 days on the LoC.

  6. Agreed that there is little point to optimize. An 8% opportunity cost is really optimistic. The only place you'll get that return is from a really good portfolio, in which case it's not liquid enough to manage monthly bills.

    I value my time greatly, so all my bills eligible for pre-authorized payment go to my credit card to maximize its cash-back option. In turn, the credit card is pre-authorized from my chequing account (along with one or two bills that don't support credit cards). I never miss a payment this way. My missing opportunity cost is that I must ensure I have a cushion in my chequing account (currently ING paying 0.25%), so I try to keep that balance around $2K. I find the lack of worry and ease of management to be more than worth any missed opportunity costs!

  7. @GK: Your system of pre-authorized payments with your credit card is interesting. As you say, as long as you can cover the bills each month, it works well. I prefer not to allow each bill collector access to my bank account or credit card, but we each make our choices.

    Liquidity of a portfolio is not a factor in calculating opportunity costs. Whatever buffer you maintain to pay bills will be the same whether you pay bills at the last second or some number of days early. So, it is the long-term savings (a portfolio) that gets cheated by paying bills early.

  8. Most online banking allows you to postdate the payment. Just set it up to 3 days before the bill is due.. you save some of the pennies and won't miss the payment.