How Interest Works When You Borrow Money

In our second mini lesson on interest, we will learn how interest rate and APR work when you borrow money from a financial institution.

Interest on Money That is Borrowed

When you borrow money, interest is what you are charged for using that money. This means you will end up paying back more than the initial amount borrowed.

This is a fundamental way of how banking and credit services work. Interest rates can vary based on your credit score, perceived risk, and the type of borrowing.  Let’s look at how interest works on credit cards.

Interest on Credit Cards

Credit card rates are advertised as APR, but interest is calculated daily and billed monthly. Most lenders allow a 30 to 40-day grace period where purchases are interest free. The only time that you will pay interest is when you carry over an outstanding amount to a new billing period.

Credit card interest is calculated by multiplying the average daily balance of the billing period by the daily interest rate.

Daily interest rate is simply the APR divided by 365. Some banks and lenders use variations of this formula so there’s no hard and fast way to calculate it.

If you are confused or concerned about credit card interest, then always talk to your lender for a complete explanation.

Never sign any credit or loan documents if you do not have a solid understanding of the terms. Speak up and ask questions.

That’s it for this lesson.  Our next mini lesson will focus on how interest works on your savings.

Let me know if you have questions!

Dr. Linda