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Credit: You Pay to Use It

Interest is the price of using someone else's money. When using credit, you agree to pay the original amount of money (the principal) and an additional percentage of the amount borrowed, which is called interest. An interest rate is the amount of interest charged, expressed as an annual percentage rate (APR) of the amount borrowed. When you borrow money, you need to consider the interest rate in order to calculate the total amount you’ll owe.

For example, suppose you borrow \$1,000 and repay the full amount within one year. The difference between borrowing the money at a 10% interest rate and a 5% interest is \$50:

\$1,000 1-year loan x 10% APR = \$1,000 x 0.10 = \$100
\$1,000 1-year loan x 5% APR = \$1,000 x 0.05 = \$50

The total amount of interest paid on a loan will vary depending on the interest rate and the principal of the loan. The principal of a loan is the amount you still owe after each payment is made.

Now suppose you borrow \$2,000 at a 10% interest rate and repay the full amount within one year. The interest on this loan costs twice as much interest as borrowing \$1,000 for a year at the same interest rate:

\$1,000 1-year loan x 10% APR = \$1,000 x 0.10 = \$100
\$2,000 1-year loan x 10% APR = \$2,000 x 0.10 = \$200