Interest - Not a Nightmare - Part 1

In the modern age of plastic money, I always wonder why a lot of people still run away from a Credit Card. Whenever I talk to them, I find out that not having Credit Card everyone has two common reasons:
1. Humongous Interest Charged by Credit Card Company,
2. Not able to manage extra expense.

Managing expenses are based on individual choice and priority. We can't tell anyone that how they can manage their expenses. But I can tell, how can we save us from getting charged huge interest. Before that we have to understand the interest.

Usually interest are of two type:
1. Simple Interest,
2. Compounding Interest.

Simple Vs Compounding Interest

The basic difference between Simple Interest and Compounding Interest is that we calculate Interest on Interest in case of compounding interest.

For interest calculation on credit card companies use following methods for interest calculation:
  • Monthly,
  • Daily,
  • Monthly Using Average Daily Balance.

Monthly: By using this method interest got calculate using monthly balances (Statement Balance). 
Example: 
Annual Percentage Rate(APR) = 15% 
10 Jan Purchase 100000.00/-
09 Feb Statement 
Interest = 100000.00 * (15/100)/12 = 1250.00/-

Daily: Whenever company using this method they calculate interest on daily basis and at the statement accumulate and charge.
Example: 
Annual Percentage Rate(APR) = 15% 
10 Jan Purchase 100000.00 /-
11 Jan Interest = 100000.00 * (15/100)/365 = 41.10/-
12 Jan Interest = 100041.10 * (15/100)/365 = 41.11/-
13 Jan Interest = 100082.21 * (15/100)/365 = 41.13/-
Payment = 1000.00/- 
14 Jan Interest = 99082.21 * (15/100)/365 = 40.72/-

Monthly Using Average Daily Balance: This is the most widely used method of interest calculation among credit card companies. In this method we calculate the average balance across month and charge interest at the statement on the basis of average balance.
Example: 
Annual Percentage Rate(APR) = 15% 
10 Jan Purchase 100000.00 /- Account Balance=100000.00/-
15 Jan Payment = 1000.00/- Account Balance=99000.00/-
09 Feb Statement 


Average Daily Balance =99161.29
Interest = 99161.29 * (15/100)/365 * 31 = 1263.29/-

Account balance has different components, i.e. principal, interest & different fees. Usually credit card company charge interest on each component. 

If we are not charging interest on interest, then interest calculated by Daily Method and Monthly using Average Daily Balance will be same.

This is how Interest got calculated by credit card by companies. I will discuss more on this as well as explain you how you can save yourself from interest.

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