Money, Banking and finacial marketsWhat will be the amount owed at the end of the year if a borrower charges $100 on his/her credit card and doesn't make any payments during the year (assume the...
What will be the amount owed at the end of the year if a borrower charges $100 on his/her credit card and doesn't make any payments during the year (assume the interest rate is 1.5 % per month)?
In the case of compound interest, I have been advised that it is a good idea to pay off almost all of your credit balance before it is due, but leave a little money to roll over; this allows your credit history to remain strong at the cost of a small amount of extra payment. However, Dave Ramsey advises cutting up your credit card entirely, paying it off slowly, and then cancelling your account; I am in favor of this but I have found today that a basic credit card is a useful safety net when my paycheck is late. (Protip: never ever sign up for a credit card with an annual fee, whatever the reason.)
I defer to those more mathematically knowledgeable than I am (that is, to 99.99% of the population of the planet). Instead, I would note that this is essentially what many governments around the world have done: they have run up huge debts that seem impossible to pay down. If I do this with my credit card account, I am the one who will eventually suffer; if the government does this with its various kinds of debt, everyone will ultimately suffer.
The first month, the interest accrued would be 1.50 which means the new balance will be 101.50. Each subsequent month, the interest on the account will be based on the new balance, not the original balance. Therefore the interest each month will increase. After the second month, the balance will be $103.02 and continue to increase until after the 12 month when the balance will be $119.56.
As post #2 mentions, the compounding monthly interest is what really brings up the total amount owed, which is important to pay attention to when using credit cards. The other factor that struck me with your scenario is that credit cards always require some sort of minimum monthly payment, and if those payments are missed or late, there will be other fees added to the balance.
I believe that the interest on this credit card debt will be about $21.41 at the end of the year. That means that you will owe $121.41. This is based on the idea that a 1.5% monthly rate of interest is equivalent to a 19.56% annual interest rate because of compounding. Again we see how compunding adds to debt (or to gains if you are saving).
Yes, the compounding monthy interest represents the hidden cost of buying things on interest and should make us all very aware of the dangers of doing so. Your scenario highlights the necessity of making very sure you are aware of all costs, hidden or otherwise, before you sign up to any credit card scheme.
I think this would depend on how the credit card charges interest. I am not sure that all cards charge it the same way, and some card issuers are sneaky. There are fees that also might make these numbers change. Sometimes they add a fee, and you end up paying interest on that too.