Understanding Interest on a Personal Loan vs. Credit Card: How is it Calculated?

Interest is the cost of borrowing money, and it’s crucial to understand how it works, whether you’re using a personal loan or a credit card. At Customer First Financing, we believe in empowering our clients with the knowledge to make informed financial decisions. Today, let’s delve into understanding the interest on personal loans and credit cards and how they’re calculated.

Understanding Interest on a Personal Loan

Interest on a personal loan is usually calculated using the simple interest method. Here’s how it works:

Determine your daily interest rate (also known as your annual percentage rate, or APR) by dividing your annual interest rate by 365.

Multiply your daily interest rate by your outstanding loan balance. This gives you the amount of interest you’re charged per day.

Multiply the daily interest by the number of days in your billing cycle to get the total interest for the period.

Personal loans typically have a fixed interest rate and a set repayment schedule, which means your payments stay the same throughout the term of the loan.

Understanding Interest on a Credit Card

Credit card interest, on the other hand, is calculated using the average daily balance method, which takes into account the balance on your card each day of the billing cycle. Here’s how it works:

Each day, the card issuer calculates the daily balance and then multiplies it by the daily interest rate (your APR divided by 365).

At the end of the billing cycle, the card issuer adds up all the daily interest charges to determine the total interest for the month.

Unlike personal loans, credit cards usually have variable interest rates, which means the rate can change over time. Also, if you don’t pay your balance in full each month, you’ll continue to accrue interest on your outstanding balance.

The Difference Between the Two

While both personal loans and credit cards can help you manage finances, they work differently. A personal loan is a fixed amount of money borrowed all at once, repaid over a set timeframe, and often has a lower interest rate. A credit card, however, allows you to borrow as you go, up to a certain limit, and can carry higher interest rates, especially if balances aren’t paid in full each month.

Before choosing a personal loan or a credit card, it’s essential to consider your financial situation, needs, and the potential cost of the interest over time. If you need further guidance, our team at Customer First Financing is here to help. We’re committed to helping Canadians understand and navigate their financial options. Reach out to us today for more personalized advice.