Credit and Its Cost
What is Credit?
Credit is money granted by a lender (or creditor) to a debtor (or borrower) whereby the lender defers receiving payment of the debt for a period. In exchange for the credit allowed, the lender will get back the money lent plus interest. The borrower has use of the money immediately, rather than waiting until the money required is saved up.
It enables the borrower to pay for things immediately, even if they cannot afford to pay for it themselves. Interest is the compensation required by the lender for the use of his/her money. There is a time value to money because of inflation, by way of an interest charge.
What is the Cost of Credit?
The cost, or charge, for using credit debt is called interest. This interest can either be simple interest or compound interest.
- Simple interest
This is interest charged only on the principal amount borrowed. Simple interest does not add interest that's due, back on to the principal amount because it is usually paid out. - Compound interest
This is interest charged, not only on the principal amount owing, but also on the interest that has been accrued on that principal amount. The interest is added on to the principal and then the new interest is calculated on the new total of those two items.
What happens is that there is a compounding effect, so that interest is charged on the interest. The result is that the lender receives a higher and higher return because the interest charge is levied, not only on the amount originally lent, but also on all interest due on the amounts over the term of the loan.
APR - Interest Rate
The APR is the reference to the interest rate the lender charges the borrower for the use of the money. You need to know a little about APR because it shows what the cost of the credit actually is. The cost of credit is more than just knowing the interest rate; it is important to be familiar with the annual percentage rate.
The APR is the cost of credit measured on a yearly basis and expresses a yearly rate. By comparing the APR of loans or credit cards etc you can work out which card is likely to cost you the most. You need to find out what the correct annual percentage rate being charged to you is so you can make decisions on your lending situation because it will affect the selection of credit cards or other loans you are looking at taking on.
Using the APR to your Advantage
If you carry a balance from month to month on your credit card and the card has a high APR, the only way to reduce the interest is to pay more each month. If you only pay the minimum amount, not only will it take you a long time to reduce your debt, but you will also pay more interest.
All the time you carry a balance on the card, the interest adds up. A credit card balance can actually increase considerably when you only make the minimum payments. This is because the balance on your card is left to accrue interest over time and so it just keeps growing. Check out what the APR is because the lower your APR, the lower the fees charged to you.
What's the Difference Between a Fixed and Variable Rate?
- Fixed - A fixed interest rate means that the rate of finance charged does not change throughout the term of the loan. For example, you may take out a loan at 5% fixed for three years. This means that the interest rate will not change over that three-year period and will remain at that 5%.
- Variable - A variable rate, however, is determined by an index such as the prime rate charged by banks. The variable rate allows the bank to charge an interest that more correctly reflects the current market conditions.
When shopping for a loan, make sure you understand clearly the difference between a fixed and a variable rate.
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StartRunGrow (http://www.startrungrow.com) is a global online information organization that specializes in creating, developing and marketing business help information specifically with the aim of "making business easier" for entrepreneurs around the world. The StartRunGrow objective is to become a dominant player in the business help arena providing end to end solutions for the millions of small and medium businesses worldwide who continue to struggle daily with the difficulties of starting, running and growing a successful business.
MORE RESOURCES:
 China Daily | Stock markets end week of credit crunch worries Newsday, NY - Credit-crunch worries continued to weigh on US stock markets Friday, but the hemorrhaging evident for most of the week was contained. ... Video: Stocks Fluctuate After Fed Corporate Debt Plan Paulson OKs Bank Stock Purchase Plan Easy credit and financial crisis |
 AFP | Tighter credit card limits add to woes MiamiHerald.com, FL - Now credit cards may become the next focus of the credit crisis. BY FRED TASKER Maria Osorio, 62, of Sunrise, never meant to run up her credit cards the way ... Credit Crisis Collapse What Happens Next? Regional financial experts focus on lending; say credit crunch is ... Market news this week for strong stomachs |
 Boston Globe | Global leaders seek answer to credit crisis San Francisco Chronicle, USA - At the same time, loan markets everywhere remained broken, especially the critical wholesale credit markets, in which financial institutions lend each other ... Video: Bernanke: More Economic Pain Ahead TREASURIES-Surge in Europe as shares skid on credit woes Stocks down despite government moves to free up credit |
 The Associated Press | US will work with partners on credit crisis: Bush CBC.ca, Canada - It was the 21st time in 26 days that the president has spoken publicly about the credit crisis gripping financial markets and dragging down stock markets. ... Meeting G7, Bush Vows World Economic Fix |
 China Daily | Lehman Credit-Default Swap Payout Could Climb as High as $365 Billion Washington Post, United States - By Heather Landy NEW YORK, Oct. 10 -- In what may shape up to be the most expensive payout ever in the credit-default swap market, sellers of insurance ... STOP FINANCIAL WMD'S: Credit Default Swaps Insurance on Lehman Debt Is the Industry’s Next Test Lehman Credit-Swap Auction Sets Payout of 91.38 Cents (Update1) |
Is my credit union safe? Los Angeles Times, CA - By E. Scott Reckard, Los Angeles Times Staff Writer The government-run National Credit Union Share Insurance Fund insures most deposits at credit unions, ... Got Your Money in a Credit Union? You Too Are Safe In tumultuous financial times, credit unions might be an option to ... LETTER: Your money is safe with credit unions |
Fears Grow That Tight Credit Could Crush GM, Ford NPR - Standard & Poor's downgraded the credit of both companies and their financing arms this week. AFP/Getty Images Ford F-150 trucks sit at a dealership in ... Video: Money Minute: GM, GE, Oil GM, Ford too big to fail? CREDIT WATCH HITS GM, FORD |
Financial troubles spread to credit unions Los Angeles Times, CA - By E. Scott Reckard, Los Angeles Times Staff Writer It's not just giant banks on the brink these days: Losses are clobbering nonprofit credit unions that ... |
 New York Times | Credit cards, credit crunch: consumers feel pinch as issuers `go ... Newsday, NY - The credit crunch and weak economy also are taking a toll on credit cards. Perhaps you have noticed that you're receiving fewer offers for credit cards in ... Your Money One Thing You Can Control: Your Credit Score |
 Boston Globe | Transcript: President Bush's Radio Address FOXNews - The Fed has joined with central banks around the world to coordinate a cut in interest rates — a step that should help free up credit. ... Text of Bush's remarks Friday on the economy Comprehensive strategy to tame crisis: Bush Bush says financial rescue plan big enough to work |
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