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With credit cards becoming even more popular in today’s touchless, cashless world, understanding credit card APR is more important than ever. Knowing how it impacts your costs can help you manage your spending and avoid surprises when using your credit card.
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What Does APR Mean
APR, which stands for Annual Percentage Rate, represents the annualized interest rate charged by the credit card company for borrowing money. This term applies to various forms of lending like mortgages, auto loans, and personal loans. It's worth noting that APR for loans may include fees, while APR for credit cards typically does not.
How Does APR Work
APR is the interest charged for purchases made with the credit card and is based on purchases that still have a balance on the card for a given billing cycle. It’s calculated by multiplying the daily periodic rate by the average daily balance, then by the number of days in the billing cycle.
Daily Periodic Rate
This the APR divided by 365 (the number of days in a year). If the APR is 24%, the daily rate would be 0.00066 (24 divided by 365). Some lenders will use 360 instead of 365, in that case the daily rate would be 0.06666 (24 divided by 360).
Average Daily Balance
The average daily balance is the sum of your balance each day in a billing period divided by the number of days in the billing period. If you had a credit card balance of $500 at the beginning of the billing period and didn’t make any purchases in the billing period, the average daily balance would be $500.
Days in a Billing Cycle
The average billing cycle for a credit card is between 28-31 days and can vary by lender. It’s possible that the days in your billing cycle could fluctuate from month to month to account for the differing number of days in each month.
For a month with a 30-day billing cycle, average daily balance of $500 and an APR of 24%, the interest charged that month would be calculated as average daily balance multiplied by days in the billing cycle multiple by the daily periodic rate. In the case of our example that equates to $9.90 ($500x30x0.00066). It will cost you nearly $10 for the privilege of borrowing $500 that month.
Is APR different than Interest Rate
APR is APR, however the calculation of the APR could vary. For most types of loans, calculated APR is different than just the interest, because the APR will often include upfront fees charged by the lender (typically for loan processing), these fees added to the loan make the starting principal balance higher, and thus the calculated interest higher.
Credit cards are different, in that any fees if they are to be charged, such as annual fees, late payment fees or over limit fees, will simply be added to the balance on the card at the time they are incurred. This effectively makes the credit card APR and interest rate calculations the same.
Types of APR’s
A single credit card can have multiple APR’s to address a variety of scenarios that may occur with the credit card user. These scenarios include purchases, promotional APR’s to attract new users, balance transfer APR’s, cash advance and penalty APR’s.
Purchase
The most common APR associated with a credit card is the purchase APR. This is the rate for all purchases made with the card. Since this will be the APR that could potentially cost the most over time, as you use your credit card; this is the APR you want to be most mindful of.
Purchase APR could either be a variable or fixed APR. Fixed interest APR means you are charged the same rate each month and can expect that this rate will not change. Variable APR means the rate is tied to the prime rate and can fluctuate up or down, dependent on the marketplace.
Most credit cards use variable APR’s. This means the interest could have been 10% when you signed up for the card but if interest rates have risen overall, it’s very likely the interest on your card has risen as well. This means you will pay more each month, so it’s important to pay attention to your statements and watch your spending, to ensure you aren’t paying more than you are comfortable with.
Introductory
A very popular promotion credit card issuers will use is to offer an introductory APR. This is a temporary APR for given period that can be as low as 0%. Once the trial period has ended, the APR will immediately jump to whatever the purchase rate APR is for the card, as stated when you accepted the credit card.
If you are going to make a large purchase that you believe you can pay off before the end of the trail period, an introductory APR could be a great way to save money on interest.
Balance Transfer
Another way credit card issuers will lure customers from one company to another is to offer an attractive balance transfer APR. This APR would be charged only to the amount of money you transferred from one credit card to the new one. The balance transfer APR can also be as low as 0% for a given period of time, typically 6-24 months.
Check out Best Balance Transfer Credit Cards
Cash Advance
Not all APR’s are less than the purchase APR. Cash advances are when you borrow cash against the credit limit on your credit card. Typically cash advances are used for expenses you cannot normally pay with a credit card, such as rent for example.
Credit card companies prefer you use their credit card for charged purchases because they get paid a fee from the merchants when you use your card. Cash advances offer no benefit to the credit card company. As such, the cash advance APR for is often greater than that of the APR for purchases. If you can help it, avoid credit card cash advances to save money in interest.
Penalty
Lastly, it’s important to pay your monthly payments on time for your credit cards. Not only because you want to build good credit and have a strong credit history but also because missing payments (typically 60 days or more past the due date) could trigger a penalty APR. This is also a higher APR that you will be charged for purchases.
The penalty APR is not permanent, The CARD Act, passed in 2009, provides that after six-months of on-time payments, your APR will go back to your purchase APR. Should you miss payments again in the future you could see this penalty APR return. Check with the credit card issuer to understand what terms they offer in this type of instance.
How Do You Get the Best APR
To get the lowest APR, focus on maintaining excellent credit. Starting with a basic credit card to build your credit is fine. Be responsible with your spending, stick to your limit, and make timely payments. As your credit score improves over time, better APR options will become available to you.
