Credit Articles
~ Low Interest Credit
Cards
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 $1322.50. It goes on, with totals like
this: $1,520.88, $1,749, $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%: $1120, $1254.40, $1404.93, $1573.52…
$1762.34 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.
.
Credit Card Resources
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Secured Credit Cards
About the Author
Liz Roberts is a loan consultant with NewHorizon
Finance and has been providing consumers
and business owners with financing since 1989.
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