How Interest Is Charged

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How Interest Is Charged

To find out how you’re being charged interest, you’ll need to pull out your credit card bills and installment loan statements and the disclosure forms for any other loan contracts you have.  Just looking at the initial interest rate stated in the contract will not give you the real picture; the real interest rate that they show on your account may in fact be almost twice as much as the number stated in the contract, depending on how interest is computed on the unpaid balance.  For example, let’s assume you decide to bore $500 for one year at 10% interest. If you have any trouble understanding these numbers, give your credit card company or bank manager a call and ask them to explain how your specific loan interest rate is calculated.

If your lender calculates interest on an add-on basis, your interest and $50 will be added onto your loan amount the day you borrow the money, so you’re typically borrowing a $550 from day one.  With this method of calculating interest, the effective annual rate on this loan will be 18%, not the 10% stated in the contract. There may also be processing fees associated with your loan, which pushes the effective interest rate even higher.

Instead of add-on interest, you’re lending agreement may say that interest is computed based on the discounted interest method.  This means of the interest you owe is deducted from the proceeds so that you end up with $450 in your pocket, instead of $500.  In that case, the real interest rate is almost 20%. While you are checking how the interest rate is computed on each of your debts, also look and see which balances are being used to compute interest charges, as well as when interest begins on any new charges.

Credit Card Interest

With some lines of credit, credit cards, there is a grace period – here, interest is not charged on the purchases until the end of the statement period.  This means that, for example, if you charge something at the beginning of the month, receive a statement on the 15th of the month reflecting this new charge, and pay the entire balance when it is due at the end of the month, no interest is due on those charges.  However if you miss the due date by even one day, interest may be charged from the first day that you carried a balance at rates that are in the 18% range for bank credit cards and 29% for store based credit cards. Other lines of credit and credit cards start charging interest the day the charge is actually incurred.

Once you miss the due date on your statement, interest is calculated daily on the unpaid balance. So for example if you are still using your credit card to make purchases, interest is being charged on these new charges from the day they are charged to your credit card as well as on the unpaid balance. Interest charges can really add up in hurry and make you wonder if you ever will be able to repay your credit card debt.

Paying Your Unpaid Balance Can Save You Money

As we mentioned, interest is calculated daily on the unpaid balance of your credit card debt. Any payment that you may make to your credit card is allocated first to the accrued interest and if there is any money left over, it will be allocated to the amount of principal that you actually owe.  Consumers who pay the minimum payment each month are paying over 90% of the payment to interest charges and only a small amount towards the principal. As a result it can take a very long time to actually repay the credit card debt in this manner. Consumer are much further ahead if they pay larger amounts on their credit cards to reduce what is owed quickly and minimize the total interest that they actually pay.

Consolidate Loans to Reduce your Interest Costs

Many consumers will take out small loans at relatively low interest rates compared to credit cards to reduce the total amount of interest that they are going to pay on their loans. A personal loan at 4 % for example will be far less costly than a loan or credit card debt that has interest rates in the 20% range.

Whenever you must carry debt of any kind, always attempt to arrange for loans that have as low an interest rate as possible with no fees as well to reduce your interest costs. Interest on loans may be calculated every 30 days or any time you increase or decrease the loan. At these low rates you can really save a great deal and use the savings to repay the loan even more quickly.

Focus on obtaining the lowest interest rate available with zero fees to minimize your costs and total interest paid on any debt that you may have. You can save hundreds if not thousands of dollars by taking this approach, and put more money in the hands of yourself and that of your family.  Keep interest rates low.