Hypothetically, lets say you charged $1,000. And let’s say that your interest for that month was $10. Assuming you don’t pay anything off the card, will the interest for the next month be figured based on the actual amount of charged goods ($1,000), or on the complete total ($1,010)?
It can, I suppose, vary with the card. But most charge interest on your entire balance, so, yes, they charge interest on interest. Some have minimum payments that barely scratch the principal.
Good question! When I was younger my poppa told me that it was against the law to charge interest on interest. But, I did a little digging in my files and my Visa cardmember agreement states:
“(1) Finance Charges (Due to Periodic Rates) will be imposed each day (a) on purchases, advances and Fees beginning on the day they were posted to your account and (b) on Finance Charges beginning on the day after the date they were accrued in your account…”
There’s other language about paying your monthly minimum and other stuff, but, I would say that, at least in my case, under certain circumstances, the answer is definitley YES!
Dang, more reason to pay off that bill.
I believe that you are referring to the compounding of interest. If they wanted to, they could recalculate each day for the amount of interest you had accumulated. They can even, without much work, calculate interest that gets compounded every infinitessimal piece of time. This is called continuously compounding. Check your credit card agreement to see how often the interest on your card compounds.
Perhaps someone who knows more than me will be along to provide the formulas for calculating compound interest.
Sure they compound the interest. Did you really think a bank would pass up the opportunity to make more money?
The compound interest formula is:
Compound Interest Formula
FORMULA: A = P(1+r/n)nt
A = Amount accumulated after t years (A = Principal + Interest)
P = Principal
r = interest rate changed to a decimal Ex: 4.5% = 0.045
n = number of times compounded Ex: semiannually = 2
t = Number of years invested
Mathematically, you can evaluate this equation if n = infinity (i.e, continuous compounding).
Oops. The “nt” at the end of the equation should be superscripted.
With n = infinity, the equation evaluates to A = Pe^(rt). E is the mathematical constant 2.7182818…
To see that it makes sense to charge interest on the interest, ask yourself whether principal or interest is paid back first. If there is interest on the interest (i.e. if interest is compounded) then there is no problem - you owe some money and you’re going to be charged interest on your outstanding debt. However if interest isn’t compounded then this is an issue.
Assume principal paid back first.
Spend $1000. Charged 1% in the month. Pay back following month. Repeat.
At the end of this you will owe $20. However this money is all “interest” and so you don’t pay further interest on it. As such there is no incentive to pay it back. You can leave that $20 there as long as you wish.
Clearly this is unacceptable. On the other hand if you start having to pay back interest before principal you are still having to pay interest on that principal, meaning that in effect the interest is accruing interest - the situation we supposedly wanted to avoid.
So it’s logical to compound interest. It’s all just money that you owe anyway. Who cares what circumstances lead to you owing it?
pan