One thing I've never seen talked about on this board or anywhere else for that matter is that credit cards seem to charge you more than the stated interest rate. If you dig intothe paperwork they send you generally the way they compute interest is by taking the interest rate say 20% and divide it by 365. That is the daily rate which is applied to your balance daily. Which means that it is compounding DAILY which means that the effective APR is higher. It generally works out to be 1% more at a 10% APR and 2% more at a 20% APR. It is much like bank accounts where the more often they compound the interest(ie monthly, weekly, daily, continuously) the higher the effective interest rate. My question is how do they get out of the truth in lending act which requires (as far as I understand it and I'm no expert)the disclosure of the simple yearly interest rate. I know we have some math whizzes on this board too, so back me up or show me where I'm wrong on this.
The rate they quote is the nominal rate, it is relatively easy to calculate the effective rate. I didn't think they (the cc companies) were require to state the effective rate?
I thought I might as well post the formula you would use to figure out the true apr. True APR=((1+(APR/365))^365)-1 The APR should be a decimal not a percentage--12%=.12 Also some credit cards compound monthly, but the result is still about the same.
It's actually 365.25, and the above formula works for simple interest loans only. Using that formula you can calculate how much interest accrued since your last payment, and what your payoff balance will be given a certain date. The CC companies extend this formula a bit further to compute the average daily balance, the most common method. They multiply today's balance with the daily interest rate to get a final balance. Tomorrow (& daily till the end of the billing cycle) they will do the same PLUS yesterday's final balance. At the end of they billing cycle, they will take the aggregate and divide by the number of days in the billing cycle, which is then used to calculate your finance charge. That's why it's imperative to pay your bill ASAP instead of waiting till the due date. If you don't carry a balance then this is meaningless. If you're a bit of a control freak like I am, plug this into a spreadsheet & voila! Last time I checked mine was only off by $0.03.
BTW, Direct merchants bank used to post the nominal rate & the effective rate side by side, which totally horrified me and got me to start paying down my debt. They don't show both anymore. I guess too many people wised up.
Rina, The effective rate calculated using that formula is the effective rate and it is not for simple interest loans. The nominal rate quoted applies directly to simple interest loans. This effective rate calculation depends on the compounding period. Simple interest loans do not have coumpounding. The effective rate calculated here is an annual rate. You could also calculate an effective monthly rate as well.
using 365.25 vs. 365 really doesn't make a difference. You could probably even compound it continuously and it would be virtually the same number. I do know my math on this subject, I scored perfects on all of my math college entrance exams(SAT math, SATII math2c and calculus AB test) and I've derived the equations for these loan and the more complicated mortgage loans. Anyways, my point is they're being less than honest(big surprise). RIght now I'm trying to do a little searching for the laws on the truth in lending act.
