Credit card interest charges - can any help?
A colleague and I have been discussing a way to find out the monthly
interest rate charged by a credit card company against a given
balance. Here's what we came up with...
Credit card balance: £2063.95
Credit card APR: 15.9%
Interest applied: £27.43
Now we have worked out that £27.43 (the interest charged this month)
is 1/12th of 15.9% of the balance which seems like a fair way to
process the interest given that the balance changes from month to
month.
However, if we compound the given value as a percentage it comes out
not to 15.% apr but over 30%
£27.43 is 1.329% of the balance. Compound this over 12 months and you
get and APR of 30.359%
If the APR is stated as 15.9% we worked out (very roughly by a process
of elimination) that the monthly interest should only be 1.2595%
(which compounded to 15.93%). 1.2595% of the balance is only
£25.99(545) which rounds to £26.00.
It seems the banks are doing us a favour by giving us an APR, but
doing themselves a HUGE favour by dividing the APR by 12.
Now, I'm not out to discredit banks or credit card companies, but
would like to understand how they do it so I can sleep at night
Question: If the APR is stated as 15.9% we worked out (very roughly by a process
of elimination) that the monthly interest should only be 1.2595%
(which compounded to 15.93%). 1.2595% of the balance is only
£25.99(545) which rounds to £26.00.
Answer: You must have copied it down wrong and meant 1.2395% instead of 1.2595%.
Try 1.237238% :-) You may well find that the contract rate is 1.2375%
per month or 14.85% per year -- they don't work out what the monthly rate
is by reference to the APR, they have a contract rate and compute the
typical APR from that.
Question: It seems the banks are doing us a favour by giving us an APR, but
doing themselves a HUGE favour by dividing the APR by 12.
Answer: That's not what they're doing, it's coincidence. Anyway, it's more
linke 15.948%.
Question: Now, I'm not out to discredit banks or credit card companies, but
would like to understand how they do it so I can sleep at night!
Answer: Unless the balance of £2063.95 has been constant for a whole month
since the last payment was made, and there have been no purchases
since then, it doesn't make sense to work out what percentage of
the balance is represented by £27.43. Bear in mind also that some
purchases in the previous statement period may have been potentially
interest free, but if not settled last month, then interest on them
will run from the transaction date, and so the interest-generating
period on part of the balance will be longer than a month.