What You Need to Know About Interest Rates

For all people shop around for the best rate, there are few who have taken the time to sit down and add it all up. After all, why would you bother? The answer is that understanding just how interest rates work can help you see how important small differences in rates and payment amounts can be.

Interest Rates are Compound.

It is important to remember that what you owe is compounded ? that means you pay interest on the interest you owe from the month before. That means that if you're paying 2% per month in interest, you're not paying 24% per year ? you're actually paying 26.82%. Charging interest monthly instead of yearly is a trick to make it feel like you are paying a very low price for your borrowing.

A Thought Experiment.

Here's a question: would you rather have $1 million, or $10,000 in a savings account earning 20% per year in compound interest?

Well, let's see how that $10,000 would grow. After 10 years: $61,917. 20 years: $383,375. 30 years: $2,373,763. 40 years: $91,004,381. 50 years: $563,475,143.

So after fifty years, you'd have over $500 million?! Well, not so fast. Of course, you have to take inflation into account ? if we say inflation is 5%, then that money would have the buying power that $10,732,859 does today. Still, that's not a bad return on your investment of $10,000, is it?

That's the power of compound interest, and the way the credit card companies make their money (it's also the way pensions work, and the reason the prices of things seem to rise massively as you get older). Be very, very afraid of compound interest. Or, of course, you could start saving, and be very glad of it?

Compound Interest Adds Up.

Let's work through an example on a more real kind of scale. Let's say you have an average unpaid balance of $1,000 on a card at 15% APR.

You will owe $150 in interest for the first year you borrow. However, this amount is then added onto the balance, and interest is charged on that. The second year, you'd owe another $172.50, for a total of $1,322.50. It goes on, with totals like this: $1,520.88, $1,749.00, $2,011.35.

After just five years at 15%, you'd owe double what you borrowed. And after 10 years, you'd owe four times what you borrowed! Bet you weren't expecting that. If you let something like that carry on for long enough, you'll end up paying back that credit card for years afterwards, paying back what you borrowed many times over and still not clearing the debt. Most people don't work this out, and feel that the payments must simply be their fault for spending too much money to begin with.

One Percent of Difference.

One more thing. You might think there's not that much difference between a card that charges 15% APR and one that charges 12% APR. Let's see the difference the lower rate would make to that $1,000 borrowed for five years. Remember, after five years at 15%, you owed $2,011.35.

At 12%: $1,120, $1,254.40, $1,404.93, $1,573.52? $1,762.34 after five years. So you've saved $249.01 from that 3% difference in APR ? in other words, you've paid almost 25% less interest.

Ken Austin is the webmaster at Debt Consolidation Solutions and Credit Relief Solutions

---

How To Start A Second SEPERATE Credit File!

Your personal credit file is separated from those with the... Read More

Ten Steps To Building A Good Credit History

Are you thinking of buying a house? Do you want... Read More

Understanding Your Credit Score

When you apply for credit one of the first things... Read More

Building A Credit Report Lenders Will Love You For

Will lenders really love you for having a good credit... Read More

Debit Card vs. Credit Card, What Are The Differences ?

Ah, the "good old days". If you are a baby... Read More

Which Credit Card?

Bewildered by the sheer variety of debit cards and credit... Read More

Check Your Credit Before Shopping For That Home Loan

Review Your Credit Score.Nearly every bank, credit union, and mortgage... Read More

Credit Card Entrapment - The Secrets are Out

Have you ever wondered why your credit card bill is... Read More

Top 7 Factors to Consider While Reviewing Credit Card Offers

Credit cards have migrated from being hip or convenience product... Read More

What You Need to Know about Debt Negotiation on Credit Cards

Debt negotiation on credit cards is often referred to as... Read More

Tips For Getting Your First Credit Card

Most of us get a credit card on our name... Read More

How To Avoid Becoming A Victim of Identity Theft

With identity theft statistics currently at an all time high,... Read More

Credit Repair Kit Sound To Good To Be True? It Is.

A lot of people have bad credit. It is unfortunate... Read More

Credit Help For Renters And Others On The Horizon

Sue is a homeowner and pays her mortgage and other... Read More

Dealing With and Repairing Bad Credit

Bad credit can be a burden for otherwise good credit.... Read More

What Is the Fair Credit Reporting Act and What You Should Know About It

The Fair Credit Reporting Act (FCRA) and the recent update... Read More

Credit Report Hassles

There is no end to the amount of pain that... Read More

Fun with Credit Cards

For those of us who know how to use them... Read More

Bad Debt Recovery

Bad Debt IdentificationIdentifying bad debt is not as easy as... Read More

Bank Robbery Growing In U.S.

Bank robbery has grown to become a huge problem in... Read More

Beware the Shopping Mall Monster

Like me, you've probably been offered a fair old number... Read More

New Credit Scoring Model Could Help Millions

Mark and Beth, a young married couple in their twenties,... Read More

Which Business Credit Cards with Reward are the Best?

Thinking of applying for a credit card with a reward... Read More

Why Your Credit Score is Important

Your credit score can either haunt you or reward you.... Read More

Choosing A New Credit Card

1. Choosing A new credit cardThere are many reasons for... Read More

Understanding the Function of Credit

What is Credit?Credit is the backbone and the engine behind... Read More

10 Ways To Protect Your Financial Identity Being Used For Someone Else?s Shopping Spree

Someone impersonating you could be spending your hard-earned money.Impossible! Not... Read More

The Ghost of Expected Surprises

Here, Cratchet, what do you think you're doing?Uh, er, leaving... Read More

How Do I Establish A Good Line of Credit?

A line of credit, roughly defined, is the amount of... Read More

Guide to Credit Terms

Listed below is a useful guide to credit card terms.... Read More

What Is A Credit Report?

Even if you have heard of a credit report, you... Read More

Credit Cards and How To Choose Them:

It may seem like a simple question but its important... Read More

What You Need to Know About Credit Reports

You hear people talk about credit reports all the time... Read More