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When you have borrowed money from a lending institution it is a common fact that this debt needs to be paid. You are usually charged with an interest on your account. Interest rates are simply a certain percentage added to the amount that you owe. It is the fee that you pay for using the money that you borrowed. The interest rate grows until you pay your debt in full. Every loan, mortgage, credit card or medical bill that you receive will have an interest rate. There are two basic types of interest: simple interest and compound interest.
Simple interest is also known as “flat rate” interest. It is a percentage taken on the principal balance that is you owe.

The formula use for calculating this would be:

Interest= Principal x Rate x Time
If you have a loan for $10,000 for example, your annual interest rate is 15% then you owe $1,500 after one year:
$10,000 x .15= $1,500
If it takes more than a year (let’s say 2 years) for you to pay the loan then the computation will be slightly different:
$10,000 x .15 x 2= $3,000

Although this examples quote an annual percentage this may be broken down into monthly or quarterly percentages.

Compound interest adds more than the original amount and interest. Some other fees are added too in the balance. It is simple paying interest on interest per se. Most financial products usually use compound interest so bear in mind to pay your debts as soon as you can. It is wiser to pay more than the minimum monthly payments on your debts or you will be overwhelmed by your compounded interest.

There are terms that you need to know in order to have a better grasp of your interest rates this are:

• APR (Annual Percentage Rate): These are standardized computations that provide borrowers with a bottom-line number so that they can compare the rates that they are being charged by potential lenders.
• Prime Rate (Prime Lending Rate): This is the interest rate that commercial banks charge their customers who have good credit standing (high credit score).  These banks best customers are those who belong to large corporations. Because these large corporations have little chance of none repayment they are charged with a lower rate. Prime rate is used to calculate the interest rates that are charged to an individual lender on credit cards and loans.
• Fixed Rate: Is a loan on which the interest rate does not change during the entire term of the loan. There are instances when this can increase if the borrower did not pay on time.
• Penalty Rate: This is the amount that you pay if you are late with your payments. It differs from interest rates because of the penalty element. This is significantly altered when there is a change in the institutional rates. The penalty interest rate is fixed by the Attorney-General under the Penalty Interest Rates Act of 1983. He reviews the rates based on institutional rate together with the added penalty element. The current penalty rate appears on major newspapers every Monday under the Law List. Even if you have made your payments on time through a lender you can still be subjected to a penalty rate if your contract indicates a “universal default”. Universal default allows creditors to review customer’s credit report on a regular basis, if there is an instance when their credit score has been negatively affected then they can charge a higher interest rate.
• Variable APR/ Variable Rate: It is any interest rate that changes on a periodical basis. The change is determined by an outside indicator such as the prime interest rate. Movement above or below these levels are prevented by a predetermined ceiling rate also known as adjustable rate.

In addition to the common terms that a borrower must understand he must also know about the common types of debt.

Debt is often categorized as secured and unsecured. These terms depend on the presence of collateral of the debt. Collateral acts as the security on the loan or credit. A secured debt is one which involves collateral such as a house or car while unsecured debt for example is that which involves the use of your credit card.

Debt can also be categorized as installment or revolving. The payment schedule is the main issue here. When you are making a monthly car payment for example you are making an installment debt since the payments are made in installments. Revolving debts have to do with credit cards since the balance to be paid changes or fluctuates depending how many charges you have made throughout a specific time period. The total amount that you owe to a credit card debt will change from one month to another. Installment debts are more stable since there is an established amount set so you will not have a problem on how you will budget your expenses for a specific month.

Debts may also be categorized depending on its source. The rates offered by the banks or another provider will be lower than that offered by a retailer. It is wiser to know the specific differences that each one offers before you apply for a credit card.

Credit scores have been developed to aid banks and lenders in making their decision towards a loan application. It helps gauge quickly if the loan applicant is capable of repaying the amount that is going to be lent to him or her. It is therefore a representation of one’s credit worthiness.

The first to develop a scoring model was Fair Isaac Company abbreviated as FICO. The FICO score became a standard in the industry.  I know I have stated it a million times throughout the site, but here it is a again. The formula considers five aspects. They are Payment History, Total Debt Amount, Length of Credit History, Credits Used, and Types of Credits Availed.

When these factors are used in the formula, a credit score is drawn. Under the FICO scoring range, the scores may be around 300-850. If one’s score is around the 700 range, you are perceived by banks as a good borrower. Go beyond that and banks will never turn down your loan plus you’ll get great interest rates from them.  The risky applicants are those that have scores below 500. There will be difficulty in getting loans approved if your scores are interpreted as bad. This is the main reason why people of modest earning must sustain a good credit score or rebuild it if it’s in a bad condition.

And here are the ways to start the recovery process. First, paying on time is a good habit. A tardy or a default on your card gets reported to the credit bureau and it will hurt your score.

Second, when it comes to paying bills you may use either cash or your credit card. Rule of thumb, use cash first if that’s available. Use a credit card only during emergency or if your cash is insufficient. When it comes to paying your credit card bill, never use the same card. Check which card has the least APR to lessen the damage just in case you’d run into the possibility of defaulting in your payment.  If you’ve been a good payer with your credit card for so long, it would be wise to check with your bank if they have a lower APR promotion available that you could switch your card under. This will help a lot at the time when you aren’t able to fully pay your balance. At least the new rate becomes the basis for computing your interest.  Remember the web of credit card debt is so sticky that when you fall trap in it, the means of escape is going to be steep especially if your card has been given a high APR.

Another instrument to improve your credit score is to do a debt clearance. This is a good way to save oneself from a mounting credit card debt. You could transfer all debts to an account that is offering the least APR at a longer term. Debt repayment would be convenient for you and once your debt is cleared, you’d notice a recovery of your credit score. Never close accounts all at once. That’s not the solution and that’s not debt clearance.

Lastly, create a financial map and see where all your earnings go. Ascertain that after expenses and spending, there is still some extra cash left for your savings. Most of the trouble with finances happens because of bad spending habits. So if your credit score is bad then that is indicative of a poor fiscal management. It would be timely to reassess your spending habits to guarantee that moving forward no default would occur.   It all takes a good financial discipline to rehabilitate an awful score.

To protect the consumers from the lenders tricks the FDIC enacted the Truth in Lending Law which contains the Annual Percentage Rate. Through this law the creditor is bound to reveal the APR to a borrower within three days of his loan application. What is an annual percentage rate or APR? It is a standardize computation express in a single percentage number representing the actual yearly cost of funds as against a certain loan which may include transaction fees. The law dictates that credit card companies and loan issuers should show their credit card borrowers the APR so that these borrowers would see the actual rates for their particular agreement before they sign it.
The fees that are included within the APR differ from one credit card company to another. These fees may include charges connected to the making of the loan such as processing fee, underwriting fee, document preparation fee, private mortgage insurance, loan application fee, credit life insurance and appraisal fee. Other fees connected to the preparation of the loan are also included such as title fee, escrow fee, legal fee, tax service fee, home inspection fee, recording fee and credit report fee.

Annual Percentage Rate does not include your late fees and penalties or the one-time fee paid to a person apart from the lender. APR is use to make comparison on the “true cost” of various loans so that hidden fees may be revealed if any. APR uses a complex formula as prescribe by the Consumer Credit Act (1980). Different lenders calculate APR differently in addition to this the closing date that they assume impacts APR calculation.

The annual percentage rate on a mortgage includes the interest, compound interest and other costs which include points (money paid upfront to lessen the nominal interest rate and origination fee), loan fees, closing cost and loan origination fees.

For credit card loans the annual percentage rate is just an estimate and not the exact figure. This type of loan allows you to borrow money again after your pay all your credit card bills. If you think that your frequent borrowing will not affect your interest then think again since your interest, which is compounded monthly is going to gradually increase the total money that you owe. Credit card companies may not include the penalties from delinquent payments or maxing out your credit limit in the effective APR.

Do not use the APR to judge any type of loan you wish to apply. APR does not completely represent the cost of borrowing money it might leave out some important fees. If you are in debt and you are planning for debt consolidation the APR will provide you the best solution. Debt consolidation lowers down the APR to help you save a lot of money.

Annual Percentage Rate and Credit Cards

When you are searching for what credit card provider service you would wish to avail, then ask yourself this question “What is APR?”  Annual Percentage Rate defines how much interest you need to make on your yearly outstanding balance for your chosen credit card service. Because of the Truth in Lending Act, this APR figure is prominently displayed on your monthly bill or any credit card offer. The APR allows you to make comparisons on how expensive or less expensive is one credit card from the other. Notice the fine print since credit cards usually has different APRs for each feature that the card offers. A good example is when the APR for cash advances might be higher than for the purchases that you make.

Sometimes the low APR that maybe displayed on the ads is only an introductory rate, which will increase after a few months. So how does one calculate the periodic interest of your credit card? The truth is that there is a much more complex calculation that is involve for calculating the periodic interest. The easiest rough estimate on how much interest you need to pay each month on a given balance is by dividing the APR figure by 12 (which stands for 12 months) or better yet divide the APR by 365 (for 365 days) to discover your daily rate. This as we mentioned is just a rough estimate since we have to consider the compounded interest each month if in case you were not able to pay your balance in full.

Credit cards which boast of charging lower APR will usually compensate by charging with a higher annual fee. It makes more sense to choose a card with a higher APR but has lower annual fee since the interest rates for this cannot affect you that much. One not so known fact about APR is that credit card companies have the right to vary your APR but they have to give you a 45 days notice before doing so.  Having this information you must always read the letters send by your credit card company since it might contain this exact information that we are talking about.

Credit cards allow you to make purchases now and worry about making payments later. The APR on your credit card depends on your credit rating. With a bad credit you may be given a 15% or higher APR but if you have good credit scores then you will be offered 9% APR. For poor credit scores the APR can be as high as 30 to 35%. A common misconception among consumers is that the APR and the monthly interest rates of the credit card is one and the same, but they are not. The monthly interest rate is included in the calculation for APR.