Interested in Interest??
When it comes to finance, it’s easy to get blindsided by fees and large terms that are difficult to understand. Unless you went to a business school, it’s likely that you never got formal or clear information on what interest you might be paying on your credit card loans. If you already know how all this works, all the power to you! If not, read one as we break down how simple interest, compound interest and APR work.
Simple interest is the interest that’s thought about most when talking about traditional interest on loans or credit cards. Simple interest is, just like the name implies, very simple. It’s the amount owed multiplied by the interest rate. So if $1000 is owed and the interest rate is 10%, over a year, the interest is $100. In total the borrower would owe $1100.
This kind of interest is the most straight forward and easiest to figure out.
Compound interest gets a bit harder. This kind of interest is added back to the original, compounded at intervals set by the lender. These intervals tend to be monthly. So for the previous case of $1000 with a 10% interest rate over a year, if the interest is compounded monthly, every single month, 1/12th of the total owed is added to the balance. Since 10% of $1000 is $100, the first month $8.3 would be added to the total.
What does this mean?? At the end of the first month, the total owed would be $1008.3, and now the process repeats again. The 10% interest is taken from the total owed — $1008.3 — which comes out to $100.83, and then 1/12th of that is added to the second month. So at the end of the second month the total owed would be $1016.7. This continues for all 12 months, with the final amount being $1104.7. The difference here between simple and compound interest isn’t much (only $4 dollars) but when it comes to larger interest rates and larger amounts, this can really add up.
APR can be one of the hardest things to understand, but that’s only because banks don’t want you to understand what you’re getting yourself into! Put simply, it’s the compound interest rate a bank puts on a credit card. APRs can be tricky because they tend to be super high. Who can pay off a 24.99% APR on a $2000 credit card debt?! Since they compound monthly, the amount owed at the end is much higher than expected. The only way to truly avoid paying interest on credit card debt is to pay off the entire amount at the end of the month that the credit card was used.
Although interest can be tricky, we hope this helps you figure it out! There shouldn’t be any mystery surrounding your money and finances. Everything should be clear cut and out in the open, just like we’re trying to make it, so you can spend more time saving and less time trying to figure out what’s going on.
By Angel Torres