ABC's of Figuring Interest,The
Discusses the various ways of calculating interest and how this can affect the dollar amount paid.
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Although Shakespeare cautioned "neither a
borrower nor a lender be," using and providing
credit has become a way of life for many individuals
in today's economy. Examples of borrowing by
individuals are numerous--home mortgages, car
loans, credit cards, etc. While perhaps more com-
monly thought of as investing, many examples of
lending by individuals can be identified. By opening
a savings account, an individual makes a loan to the
bank; by purchasing a savings bond, an individual
makes a loan to the government.
As with goods and services that an individual
might buy or sell, the use or extension of credit has
a price attached to it, namely the interest paid or
earned. And, just as consumers shop for the best
price on a particular item of merchandise, so too
should consumers "comparison shop" for credit--
whether borrowing or lending. But comparing prices
for credit can, at times, be confusing. Although the
price of credit is generally stated as a rate of inter-
est, the amount of interest paid or earned depends
on a number of other factors, including the method
used to calculate interest.
Two federal laws have been passed to minimize
some of the confusion consumers face when they
bor-row or lend money. The Truth in Lending Act,
passed in 1968, has made it easier for consumers to
comparison shop when they borrow money. Simi-
larly, the purpose of the Truth in Savings Act,
passed in 1991, is to assist consumers in comparing
deposit accounts offered by depository institutions.
Provisions of the Truth in Lending Act have
been implemented through the Federal Reserve's
Regulation Z, which defines creditor responsibili-
ties. Most importantly, creditors are required to
disclose both the Annual Percentage Rate (APR)
and the total dollar Finance Charge to the b