Is Interest Considered Part of the Principal Credit Card Debt?

Understanding interest, how it is applied to the account and the effect it has on how much and how quickly one can repay his credit card debt is vitally important. While a 1 or 2 percent between credit card rates may not sound like a lot, it can have a drastic impact on how much one ends up repaying and how long it takes. Purchases made on a credit card are considered the principal to be repaid.

Principal

• The principal is the amount of money that the credit card company has lent the card holder. For legal and accounting purposes, interest accrued and principal owed are always considered separate elements of a credit card account. The credit card company earns a profit by receiving interest payments in exchange for lending its card holders money.

Grace Period

• Interest is charged on the principal balance of a credit card. When one purchases something and uses a credit card, a buyer is typically given a grace period to repay the charge without incurring any interest charges. However, some cards do not have any grace period and begin charging interest the day the transaction is made. It is import to understand the terms and disclosures of credit cards. Since many people carry a balance on their credit cards, the existence of a grace period is not the primary concern for many cardholders.

Annual Percentage Rate

• Interest rates have a huge influence on personal finances. percent image by Soja Andrzej from Fotolia.com

  The interest on a credit card has a headline rate. This rate can be locked at the time of issuance or it can be variable with market rates. The headline rate on a credit card statement is an annual percentage rate (APR) and the interest accrued is added to the statement each month. The minimum payment for a credit card includes the monthly interest accrued as well as a small repayment of principal. To calculate the approximate monthly interest that accrues to a credit card account, multiply the interest rate by the principal and divide by 12 (months). This is because the APR must be divided by the annual number of billing cycles, in this case months, although it could also be calculated daily by dividing the annual rate by 365.

Minimum Payments

• If a borrower only repays the minimum each month it can take a very long time to pay off the card. Consider a $9,000 principal balance at 5.5 percent. If the borrower repays the minimum each month, it will take about 23 years to repay the principal. However if the borrower repays little more than twice the minimum monthly, she can repay the card in as little as three years. Recall that each month the minimum payment will get a little smaller, but will still include the interest on the principal.

Default

• If a borrower misses a payment, the effects can be disastrous. Often she will be charged steep late fees, and can have her interest rate raised to the default maximum level, sometimes as high as 25 percent. On a credit card that is not repaid, the interest and late fees continue to be charged to the account. Before the account can be made current all interest charges and late fees must first be paid back. This can have a crippling effect on one's ability to repay a credit card and can push the final payoff back by years.