How Credit Works and What It Really Costs

The short version

Credit lets you borrow money now and pay it back later. The lender charges you for that, mostly through interest. Interest is shown as an APR, which is the annual percentage rate, the yearly cost to borrow.

On most cards, you can skip interest on purchases if you pay your statement balance in full each month by the due date. Carry a balance, and the interest stacks up fast.

Pay in full and skip the interest

Most of what credit costs is interest. The simplest way to win is to clear your statement balance every month, so you pay for what you bought and nothing extra.

• Interest is the main cost. Shown as an APR, the yearly cost to borrow
• Many cards charge daily. The APR divided by 365, so it can compound
• Fees add up. Annual, balance transfer, cash advance, foreign, late
• Pay in full, skip interest. Clear your statement balance by the due date

Watch the rate

• Fixed APR. Does not move with an index
• Variable APR. Moves with an index like the prime rate
• Read your agreement. The cardholder agreement spells out the rate
• Carry a balance, it stacks. Interest piles on the unpaid amount

Pay it in full, every month, on time.

Source: CFPB

Do this now

1. Pay your statement balance in full each month, on time. This skips interest on purchases.
2. Check whether your APR is fixed or variable. A variable rate can move with the market.
3. Pull your free credit reports. Checking your own credit does not lower your score.
4. If a covered loan tops 36 percent MAPR, take it to JAG or Military OneSource. That cap is the law for you.

What is credit, in plain terms?

Credit is permission to borrow money and pay it back over time. A lender gives you access to funds, and you agree to repay, usually with interest and sometimes fees. It shows up as credit cards, auto loans, and personal loans. The deal is simple: you get money now, you owe more later.

What does credit actually cost?

The main cost is interest, shown as an APR. If you carry a balance, interest gets added on. Many cards calculate it daily using a daily periodic rate, which is the APR divided by 365 applied to your balance each day. That means it can compound, so you pay interest on interest. Fees add to the cost too: annual fees, balance transfer fees, cash advance fees, foreign transaction fees, and late fees. APR is the headline number, but it is only one part of the price.

Fixed APR vs variable APR

A fixed APR does not move with an index. A variable APR changes with an index rate, like the prime rate. Your cardholder agreement spells out how and when the rate can change, so read it before you sign. If you carry a balance and only pay the minimum, the balance drops slowly while interest keeps adding up. The faster you pay it down, the less you pay overall.

Your credit costs have a 36% ceiling

Service members get an extra layer of protection on most consumer credit. Knowing it is there, and what it covers, helps you spot a bad deal before you sign.

36%

the Military Lending Act caps the Military APR (MAPR) on most consumer credit for active-duty members and covered dependents.

What the MLA does

• Folds in interest and many fees. The 36% MAPR is a full price, not just the rate
• Covers active duty plus dependents. Includes active Guard and Reserve duty
• Blocks mandatory traps. No mandatory arbitration or mandatory allotments
• Checking your own credit is free. And it does not lower your score

Know these rights before you borrow.

Source: CFPB

Get help, free

You do not have to figure this out alone. Military OneSource offers free, confidential financial counseling for service members and families. The DoD Office of Financial Readiness, known as FINRED, has free financial tools and education. Your installation Personal Financial Manager or Personal Financial Counselor can help on base at no cost. The CFPB also has consumer guides and a way to submit a complaint. All four are linked in Sources below.

FAQ

Is APR the same as the interest rate?

For credit cards, the interest rate is typically stated as a yearly rate, the APR.

Can I avoid interest completely?

On most cards, paying your statement balance in full by the due date avoids interest on purchases.

Does checking my own credit cost me anything or lower my score?

No. You can get your credit reports for free, and checking your own credit does not lower your scores.

Sources & links

• CFPB, What is a credit card interest rate? What does APR mean?: consumerfinance.gov
• CFPB, How does my credit card company calculate the amount of interest I owe? (daily periodic rate): consumerfinance.gov
• CFPB, Credit cards key terms: consumerfinance.gov
• CFPB, Know Before You Owe (credit cards): consumerfinance.gov
• CFPB, What is the difference between a fixed APR and a variable APR?: consumerfinance.gov
• CFPB, What is covered under the Military Lending Act?: consumerfinance.gov
• Military OneSource, free financial counseling: militaryonesource.mil
• DoD Office of Financial Readiness (FINRED): finred.usalearning.gov