Financial Literacy for Everyone
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Understanding Credit Costs


When you use your credit card, the issuing bank is really giving you a loan for the amount of your purchases. The bank charges a fee, called interest, for using its money. The credit card company pays the dress shop or the furniture store within a few days of the transaction, and you must begin repaying the loan when your monthly statement arrives in the mail.

All interest charges can usually be avoided by paying the balance in full within the time limit specified on your statement. Obviously, the quicker the balance is paid in full, the less interest is paid. Be sure to learn about the terms and policies of your credit card.

Interest Calculation Method

Banks use various methods to calculate interest, and it's up to you to learn how your bank computes these charges. Unlike a house mortgage or a car loan, credit card interest can be charged by the day or by the month. If you do not pay the balance in full, interest on the unpaid amount, or revolving balance, will be added to the total amount owed. When this happens, you are paying interest on interest - also called compound interest. If you have a large balance, paying only the minimum amount each month can be an expensive way to use your credit card.

The Outstanding Balance Computation Method

If the grace period runs out and you still have not paid the entire balance on your card, any new purchases you make can be included in the total balance immediately and will begin to accrue interest from the date of purchase.

Cash Advances

The issuing bank or financial institution treats cash advances like loans, not like purchases of merchandise. When you take a cash advance, interest begins to accrue differently - sometimes without a grace period and at a higher rate. Check with your issuer for the cash advance details associated with your credit card.