Interest Rates Are Compound

Business, Financing.

What you should 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. 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. After all, why would you bother?

Interest Rates are Compound. - that means that if you' re paying 2% per month in interest, you' re not paying 24% per year - you' re actually paying 282% . 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. Charging interest monthly instead of yearly is a trick to make it feel like you are paying a very low price for your borrowing. Here' s a question: would you rather have$ 1 million, or$ 10, 000 in a savings account earning 20% per year in compound interest? A Thought Experiment. Well, let' s see how that$ 10, 000 would grow.

Well, not so fast. - after 10 years: $61, 9120 years: $383, 3730 years: $2, 373, 7640 years: $91, 004, 3850 years: $563, 14 so after, 475 fifty years, you' d have over$ 500 million? 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. 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) . Still, that' s not a bad return on your investment of$ 10, 000, is it? Be very, very afraid of compound interest.

Let' s work through an example on a more real kind of scale. - or, of course, you could start saving, and be very glad of it... compound interest adds up. Let' s say you have an average unpaid balance of$ 1, 000 on a card at 15% APR. However, this amount is then added onto the balance, and interest is charged on that. You will owe$ 150 in interest for the first year you borrow. The second year, you' d owe another$ 1750, for a total of$ 1325It goes on, with totals like this: $1, 5288, $1, 749, $2, 013 After just five years at 15% , you' d owe double what you borrowed.

Bet you weren' t expecting that. - and after 10 years, you' d owe four times what you borrowed! 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. One Percent of Difference. 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 more thing.

Let' s see the difference the lower rate would make to that$ 1, 000 borrowed for five years. - you might think there' s not that much difference between a card that charges 15% apr and one that charges 12% apr. Remember, after five years at 15% , you owed$ 2, 013 At 12% : $1120, $12540, $14093, $15752... $17634 after five years. So you' ve saved$ 2401 from that 3% difference in APR - in other words, you' ve paid almost 25% less interest.