Hi all. I'm trying to understand the difference on how interest rates are handled with loans vs credit cards. Let's say a person took out a $5000 loan with a 12% interest rate. Let's say that same person has a credit card also with an interest rate of 12% and charged $5000 on it. If he paid the same amount on his card every month as equal to his loan payment, wouldn't he end up paying the same amount of interest on both products once both were paid off? Or is there some different way one or the other is calculated?
Thanks in advance. This is probably a newbie question to many of y'all, but I keep finding conflicting information online. It looks like loans charge more toward the beginning, and credit cards charge the same rate throughout.
Yes he would pay the same amount of interest.
Loans are set up with monthly payment amount for a preset number of months. So if you borrowed $5000 @ 12% interest over 36 months your monthly payment would be about $166. After 36 months you would pay about $976 in interest.
Charging $5000 On a card with 12% interest then paying it off @ $166 month for 36 months would bring the total balance on card to $0.
This is rough figuring.
Loans aren't charging more at the beginning. Instead the percentage of your $166 monthly payment that is applied to principal is less because the loan balance is almost 100%.
You can get an idea of this with your 12% interest example. Each month you will pay about 1% interest on the balance due. So in month one $50 Of the $166 payment will go towards interest. But once your balance is at $2000 only $20 Of your $166 monthly payment will go towards interest. Towards the end of the 36 month period most of the monthly payment will go towards principal.
That makes sense. I guess I was thinking since loans have a set payment amount, the interest would be the same each month, figured in and evenly distributed. Lol thanks!
@CashBackQueen wrote:That makes sense. I guess I was thinking since loans have a set payment amount, the interest would be the same each month, figured in and evenly distributed. Lol thanks!
No loan, credit card, mortgage, car loan, personal loan, or heck, even a loan from a loan shark, has a flat interest/principal structure; literally 100% of them charge the bulk of interest up front.
With the above said, there is one interesting difference between a personal loan and a credit card. Lets use your example, a $5,000 personal loan with a 12-month payment structure and a $5,000 charge on a credit card. Now lets say you win the lottery three weeks after initiating the two loans. If you pay off the credit card, you's still be within the grace period and you'd pay $0.00 in interest, for the personal loan you'd also need to pay approximately $50.00 in interest.
