5.03 Cost of Credit and Using Credit Wisely

Cost of Credit and Using Credit Wisely

  • Cost of credit is the total amount a borrower owes, including interest and other charges.
  • Using a credit card is like taking out a loan with each purchase.

Credit Card Issuers and Networks

  • Credit card issuers (e.g., Chase Bank) loan money, while networks (e.g., Visa, Mastercard) process transactions.
  • Issuers must publicize their APRs (annual percentage rates).
  • APR is the total cost of borrowing for one year expressed as a rate.
  • Periodic interest rate is the rate charged on a loan over a specific time (e.g., daily rate).

Calculating Finance Charges

  • Average daily balance is used to calculate interest, based on the sum of daily balances divided by the number of days in the billing period.
  • Finance charge (interest) is calculated by multiplying the daily periodic rate by the daily balance.
  • Example calculation: APR / 365 * Daily Balance = Finance Charge

Grace Period and Minimum Payments

  • Credit card issuers usually provide a 21-28 day grace period with no finance charges if the balance is paid in full.
  • Minimum payments allow you to pay a small portion of your statement balance with interest accumulating on the remaining balance.
  • Not paying the minimum results in late fees, added to the daily balance, and can negatively affect your credit rating.

Loan Sharks and Predatory Lending

  • Payday and title loan franchises (loan sharks) offer quick cash but typically have extremely high APRs (e.g. 550%).

    • APR = Annual Percentage Rate

  • Interest can accumulate rapidly, potentially leading to unsustainable debt.

  • Refinancing or extending loans can incur additional fees, exacerbating the debt burden.