Question

Anna pays .85 percent interest monthly on her credit card account. When the interest rate on that debt is expressed as if it were compounded annually, the rate would be referred to as the:

1) percentage rate
2) simplified rate
3) quoted rate
4) stated rate
5) effective annual rate

Answer 1

The interest rate compounded annually on a credit card account is referred to as the effective annual rate. This rate accounts for the compounding of interest, in this case monthly, providing a true representation of the annual cost of borrowing.

Step-by-step explanation:

When the interest rate on a credit card is expressed as a rate compounded annually, it is referred to as the effective annual rate. This rate takes into account the effects of compounding, in this case, compounding monthly. The effective annual rate provides a more accurate representation of the true cost of borrowing on the card over the course of a year. While the credit card might state a particular monthly or daily rate, such as 0.85% interest per month, the effective annual rate will generally be higher because it considers the impact of compound interest.

The credit card market sees significant interest paid by consumers. With a typical credit card interest rate ranging from 12% to 18% per year, and billions of dollars in outstanding credit card debts, the effective annual rate is a critical number for cardholders to understand. It shows the real annual cost of using a credit card if money is borrowed and interest payments are incurred.