# Interest and Lines of Credit

Have you ever wondered how the bank determines what your current interest earned is? Mystified by how credit card companies figure your interest charges for your account? Here’s a quick way to estimate the amount of interest you are earning or are paying on a line of credit, whether you owe, or they owe you. This assumes that you are attempting to determine only the interest portion of the loan and/or investment.

- Determine the daily interest rate. In other words, what does the bank charge you per day and/or what does the bank pay you per day. If your credit card company charges you 10.99%, divide 10.99% by 365.
- Multiply the result times the number of days in the billing period, typically 30 days.
- Multiply this result by the balance of the loan or line of credit/credit card.

For example’s sake, take a credit card or credit line with a $10,000.00 balance and an annual rate of 10%. Divide 10% by 365 (.10/365) which comes to 0.000273972602. If the billing period is 30 days, you need to multiply this ridiculously small number by 30 (0.000273972602 X 30) and this equals 0.00821917806. Now, multiply the balance of the loan by this number ($10,000.00 X .00821971806) and you get $82.19.

So, the first month you have your loan or investment, you are either billed or paid $82.19 when the billing period closes depending on whether or not you owe them, or they owe you. Remember, when you deposit money in an account, you are loaning the bank your money and they have to pay you interest.

What about the second month? Based on the first month, it seems that it would make sense that you’re earning 10% annually. If you multiple $82.19 which is one month’s interest by 12 months in one year, your result is roughly $986.00, which is 9.86% of $10,000.00. Why the difference? Probably due to the 30 day calculation and the fact that some months have 31 days, and February has 28 days, and rounding.

This number, however, is incorrect, because the second month’s interest is calculated differently than the first. To clarify, interest is never paid to you until it is earned by the bank or by you. In other words, the bank will never pay you or charge you interest until after the billing period in which you were charged or earned the interest. They can’t take it in advance. Now, the first month was calculated on a $10,000.00 balance, the second month, however, we added the interest earned in the first billing period to the balance of the note at the beginning of the second period. For the entire second billing period, the balance of your account was $10,082.19 and when the second billing period closes, the interest will be calculated against the new balance, which means the $82.19 interest amount will increase slightly.

In the second billing period, after applying the same initial calculation, the resulting amount is slightly greater than the interest earned in the first period:

Period/Month | Note Balance | APR | Days in Billing Period | Daily Rate | Monthly Rate | Interest this Period |

As you can see, you don’t earn $82.19 every month because your interest compounds.

**Credit Card Balance Transfer Pitfalls**

Credit card companies will send you from time to time offers to write checks against your credit card. Usually, two of the checks are offered at 1.99% for a pre-determined period, and one check will be for 5.99% for the life of the loan. Why is this a bad deal? Because of points.

**What are points? **

Points are the banks way of saying, “Please pay us for the service of loaning you money.” This is just like paying a cover charge at a club. You pay $10.00 at the door and it gets you the right to enter. You pay points (percentage points) upon borrowing money, one way or another. After all, the bank or lender must make a profit somehow.

So why is the credit card balance a bad deal? Well, it’s not really a deal at all. If you read the fine print, you’ll see that there’s a transaction fee charged against the amount you borrow when you borrow it. A recent example offered a rate of 1.99% on my entire balance transfer until August of 2008. What an opportunity! I earn 4.2% on my money at my bank, so why not transfer the entire card limit to my bank account and make a 2.2% profit (4.2% less 1.99%.) Not so fast!

The offer also calls for a minimum 3% transfer fee but no more than $199.00. The following table shows what a $10,000.00 loan at 1.99% would cost over the course of 8 months (January 2008 – August 2008):

Period/Month | Note Balance | APR | Days in Billing Period | Daily Rate | Monthly Rate | Interest this Period |

At the end of August, after borrowing 10,000.00 on a 1.99% balance transfer, I will have accrued an expense of $115.06 in interest. Now let’s see what I would have * earned *had I deposited that amount into my bank account at 4.2%:

Period/Month | Note Balance | APR | Days in Billing Period | Daily Rate | Monthly Rate | Interest this Period |

Now we see that my bank has generously paid me a total of $244.16 for loaning them $10,000.00 for the 8 month period. With an interest expense of $115.06 and income of $244.16, my net profit is $129.10, right? * WRONG! *Remember that wonderful credit card offer of 1.99% on any balance transfer through August 2008? There was a fee, or “front end points” charged to my account to service the transaction. This is where they make their money. Not only do they receive a fee, they tack it onto your account in the first month and begin compounding interest against it. Let’s take a look at the

*of borrowing $10,000.00 at 1.99% for 8 months:*

**real cost**Their terms say that the fee will be 3% of the balance transfer but no more than $199.00. What’s 3% of $10,000.00? The answer is $300.00, which is higher than the maximum fee for the transfer, so for $10,000.00, we can expect the maximum fee of $199.00 to be added to the balance immediately as reflected in the schedule below.

Period/Month | Note Balance | APR | Days in Billing Period | Daily Rate | Monthly Rate | Interest this Period |

As you can see, the actual cost of borrowing $10,000.00 at 1.99% over the 8 month promotional period is $316.35 which is $72.19 ** more **than my bank paid me. Not such a great deal after all. Borrowing money from your credit card company on a low rate promotion requires a much higher return on your investment than the typical financial institution can give in order to make any money. In fact, lets see just how much we would have to borrow to break even. Since the maximum fee they will charge me is $199.00 it makes sense that there would be an amount of money that I could transfer from my credit card to my bank account that would actually result in a financial gain.

If I were to borrow $12957.00 from my credit card at a promotional rate of 1.99% for 8 months and deposit it into an interest bearing account at 4.2%, I would make a one cent profit. That’s all. One single penny. So, I have to tie up $12957.00 of my purchasing power before I even become profitable and by the time I’ve done that, I’ve spent far more than one penny in time and effort, because I have to actively manage the quasi-investment, making sure that I pay down the balance on the credit card every month with the interest earned on the bank account.

**Could a promotion be helpful? **

Not if you have good credit and low rates. But, if you’re one of those who have extremely high balances on your credit cards with outrageous interest rates…well, you may not even qualify for these types of specials as they are typically reserved for cardholders who don’t use their card and therefore make nothing for the credit card company. But, if you do, you will definitely alleviate a cash flow problem but only temporarily.