What Rate Are You Paying

Depending on the issuer, a typical credit card agreement quotes an interest rate of 18 percent APR. Monthly payments are required. What is the actual interest rate you pay on such a credit card?

Based on our discussion, an APR of 18 percent with monthly payments is really .18/12 = .015 or 1.5 percent per month. The EAR is thus:

EAR = [1 + (.18/12)]12 - 1 = 1.01512 - 1 = 1.1956 - 1 = 19.56%

This is the rate you actually pay.

The difference between an APR and an EAR probably won't be all that great, but it is somewhat ironic that truth-in-lending laws sometimes require lenders to be ««truthful about the actual rate on a loan.

There are also truth-in-saving laws that require banks and other borrowers to quote an "annual percentage yield," or APY, on things like savings accounts. To make things a little confusing, an APY is an EAR. As a result, by law, the rates quoted to borrowers (APRs) and those quoted to savers (APYs) are not computed the same way.

Ross et al.: Fundamentals I III. Valuation of Future I 6. Discounted Cash Flow I I © The McGraw-Hill of Corporate Finance, Sixth Cash Flows Valuation Companies, 2002

Edition, Alternate Edition

180 PART THREE Valuation of Future Cash Flows

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