Some consumers may believe the grace period is the time during which cardholders pray they have the money to pay off their monthly credit card charges. Conversely bankers pray cardholders do not have the money to clear their monthly balances.

While there may be some truth to the jokes, the simple legal definition of the grace period is: the number of interest free days before interest charges begin to accrue. Over 90% of the bank credit cards in the U.S. offer a grace period or float period of at least twenty-five days on the purchase balance. (Very few issuers offer a grace period on cash advance balances.)

Sounds simple enough but there is a catch.

The grace period only applies to accounts with a previous purchase balance of zero dollars. Let's repeat this one more time: The grace period only applies to accounts with a previous purchase balance of zero dollars.

Unknown to most consumers there is an interaction between the grace period and the method used to calculate interest charges. About 85% of the industry employs the "average daily balance (ADB) including new purchases" formula to calculate interest. While there are some rare exceptions to this rule (discussed later) most cardholders do not have a grace period because they invariably carry a purchase balance. In other words as long as you consistently pay off the purchase balance each month you will consistently have a grace period or interest free period on purchases. If you fail to clear off the balance, totally, by the due date the grace period will disappear because new purchases are included in the interest calculation. A cardholder occasionally paying off the balance will literally see the grace period appear, disappear and appear again.

Think of the grace period as a clock or stopwatch. If you always pay off your balance by the due date each month the interest rate clock will never start. Leave even one dollar on the account and the clock begins ticking, you will now be charged interest on your previous balance and all new purchases. Once the interest rate clock starts the only way to stop it is to pay off the full amount due on the monthly statement.

Cardholders can also maximize the interest free float period by timing purchases. If you make a major purchase on the day after the close of the previous billing cycle the charge will not show up until the next statement or about 25-30 days later and then you'll have about 20-25 days to clear the balance. If you charge early in the billing cycle and pay off as close to the due date as possible you can effectively stretch the float to 50 days or more. Nonetheless the key is: you have to clear the balance each month.

The grace period, however confusing, is still the closest thing to a free lunch in America. Consumers have the option of using a free bank credit card to pay for goods and services, worldwide, without the hassle of cash, personal checks and travelers checks, and enjoy a 25-50 day interest-free-float-period before personally settling the charges. As a matter of fact about one out of every two dollars charged to bank credit cards never incurs interest charges. Last year Americans charged more than $400 billion on bank credit cards but carried interest accruing balances of approximately $225 billion.

While the vast majority of issuers take away the grace period from cardholders carrying balances, a few issuers do exclude new purchases from the interest calculation. To the other extreme the Discover card uses the "two-cycle average daily balance including new purchases" method to calculate interest charges. With the Discover card you not only lose the grace period when you carry a balance you may also be subject to retroactive interest charges on purchases made during the previous two-cycles or two month billing period. Furthermore the Discover card computes or compounds interest charges daily rather than monthly (the industry norm). Little wonder why Discover is the best example of the worst credit card in America unless, of course, you use it as a charge card only.

Sensing a competitive niche from all this American Express released a new version of its Optima card called "True Grace Card". Unlike the green, gold or platinum American Express charge cards, the Optima card is a revolving bank credit card. Optima, first launched in 1987, permits cardholders to roll-over or revolve balances from month-to- month. The new "True Grace" version of Optima, announced September 6, offers cardholders a grace period on all new purchases regardless of any balance carried forward from the previous month. In other words the Optima True Grace Card will use the "average daily balance excluding new purchases" method to calculate interest charges. Since Discover and very, very few VISA/MasterCard issuers use this method American Express is hoping consumers, once enlightened about how grace periods work, will be drawn to this new Optima product.

The primary interest rate for the Optima True Grace Card, prime +8.75%, is on par with the highest rates charged by big issuers of VISA/MasterCard and Discover. A promotional rate of 7.9% is being offered for the first six months and the grace period applies to transferred balances too. This is also the first American Express card without an annual fee as long as the card is used three times per year ($25 per year otherwise).

Is it worth switching to the True Grace Card ?

First you have to weigh the utility value or usefulness of the Optima card. American Express cards are accepted at less than 4 million locations compared to more than 11 million for VISA/MasterCard and about 2 million for Discover. Optima, like Discover, are cards you have to ask merchants before you use, with VISA/MasterCard you can assume the acceptance.

Clearly if you carry a Discover card you gain utility value and if you carry a balance on Discover you can save a pot of money switching to True GraceCard.

If you currently carry other American Express cards you can increase your payment options, maintain the same basic utility value, without an annual fee. For green cardholders that's an annual savings of $55, for gold $75 and for platinum $300.

VISA and MasterCard users would give up a substantial amount of utility value. Depending on charging patterns and payment habits you could wind up paying substantially more for Optima True Grace Card.

If you are among the 32% of VISA/MasterCard holders consistently paying off the balance each month there is little if anything to gain especially if you now have a no-fee gold VISA or MasterCard. Also it makes no sense to switch if you carry one of the popular rebate cards and pay off each month.

On the other hand if you're among the other 68% regularly carrying a balance and your current card includes new purchases in the interest calculation method then you might save a little depending how much and when you charge. Since the average VISA/MasterCard account racks up $2,500 per year in new purchases, carries a $1,700 balance and pays an average interest rate of 17.38%, Optima True Grace Card would save consumers about $3.13-$4.42 per month ($45 per year).

How does this stack up to other nationally available VISA and MasterCards offering lower interest rates but no grace period to revolvers? You'll do better switching to a lower rate VISA or MasterCard listed in this newsletter rather than switching to True Grace Card.

Assumptions: Prime (P)=7.75%; Average Daily Balance=$1700 Average Annual New Purchases=$2,500; excluding new purchases saves about $14 per year using average rate of lower priced cards.*Wachovia is one of the those rare banks offering grace periods on cash.

Wachovia does not separate purchases from cash advances.

*Wachovia charges P+0% for the first year.

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