Credit cards and auto loans trick consumers into thinking they get a great rate by using the Annual Percentage Rate (APR). Beat the system by paying twice as fast.
The average consumer has no idea what the letters APR stand for when they see them in an ad for their favorite vehicle. Even worse, many consumers fail to read the fine print on those auto loan documents they sign. Blinded by the daydream of cruising the highway with the top down, consumers often pay thousands of dollars in unnecessary interest payments on car loans.
Annual Percentage Rate (APR) vs. Annual Percentage Yield (APY)
Advertisers for cars, credit cards, and many other personal loans love to quote the annual percentage rate (APR). The Annual Percentage Rate is not the actual dollar amount of interest you will pay because it does not include the rate at which the balance compounds. For this reason consumers should always look at the Annual Percentage Yield. This includes compounding and will reflect the actual amount you pay in terms of the loan.
This is a very important concept because consumers are often led to believe they are paying a lower rate than they actually pay. You can get around this by looking at the rate of compounding on your APR loan. The more often the balance owed is compounded, the higher your eventual yield will be. Typically, credit cards compound daily, so every day you have a balance you pay interest on that balance plus the previous interest you were charged. Are you confused yet?
Beat the System by Making Smaller Payments More Often
The best way to use this information is to understand how paying your bills more often can save you money. For example, if you have a credit card balance of $1,000, compounding daily means waiting a month cost you ($1,000 x interest) the first day, then [($1,000 + interest day 1) x interest] the second day. Doing something as simple as paying twice a month (half payments each time) could save you at least $100 in interest payments on this thousand dollar loan. People who get paid bi-weekly should pay half of their credit card bill with each check. This lowers the base on which interest can be charged.
This strategy works for any loan that compounds more often than the required payment. Car loans, mortgages (some times), and credit card loans are the major bills that can be cut down significantly by paying more often. Don’t get fool by the APR. There could be a difference of 1-5% when compounded daily vs. yearly. Most checking accounts offer little or no interest, so it just doesn’t make sense to accrue interest owed while not gaining any positive benefit. Even if you don’t understand the math, take advantage of the savings by paying major bills as often as you can.
