APR refers to the interest rate expressed as a yearly percentage that you pay when carrying a balance on your credit card. With interest rates rising in 2023, understanding how APR works enables you to minimize costs and avoid expensive credit card debt.
What is APR?
APR stands for Annual Percentage Rate. It represents the yearly cost of borrowing money on your credit card. Any time you carry a balance month-to-month, the APR determines how much interest you’ll pay. Generally, the higher the APR, the more costly it is to revolve a balance.
To illustrate, let’s compare two hypothetical cards:
Card A has a 15% APR
Card B has a 25% APR
If you carried a $1,000 balance for a year, you’d pay $150 in interest on Card A and $250 on Card B. That’s a $100 difference for the same outstanding balance!
How Credit Card APR is Calculated
I’ll begin by demystifying how credit card companies calculate your APR. Essentially, it measures the cost of borrowing money on a yearly basis.
Here is a step-by-step breakdown of the calculation:
- Credit card providers start by dividing the APR by 365 to get the daily interest rate.
- This daily rate is then applied to your average daily balance for the billing cycle.
- That amount is multiplied by the number of days in the billing period.
For example, let’s assume your APR is 20% and your average daily balance is $1,000 over a 30-day billing period:
- 20% / 365 days = 0.05479% daily rate
- 0.05479% * $1,000 average daily balance = $5.48 daily interest
- $5.48 daily interest * 30 days = $164.49 total interest for that billing period
As you can see, APR significantly impacts the actual amount you pay when carrying a balance.
The Difference Between APR and Interest Rate
While often used interchangeably, APR and interest rates carry subtle differences. The interest rate solely reflects the cost of borrowing money. Meanwhile, APR includes extra fees charged by the credit card company.
So when you see a card’s APR, recognize it indicates the complete costs for using that card annually. The APR gives you a fuller picture of borrowing costs.
Types of Credit Card APRs
Now that we’ve covered the basics of APR, I’ll explore the different types of credit card APRs:
- Purchase APR – This standard rate applies to any purchases when you carry a balance month-to-month. When comparing cards, pay close attention to the purchase APR.
- Introductory APR – Issuers promote new cards with a temporary lower APR, usually 0% for a set period of 12-15 months. But once the intro period ends, the purchase APR applies.
- Balance Transfer APR – You may see a special lower APR for balance transfers from another card. It’s typically lower than the purchase APR and lasts around 6-18 months.
- Cash Advance APR – This is usually higher than the purchase APR. Plus interest accrues immediately without a grace period.
- Penalty APR – You risk triggering a penalty APR if you frequently miss payments or max out your card. Try to avoid this, as it sticks around indefinitely with some issuers.
Also Read: What is a Student Bank Account?
Finding Your Credit Card’s APR
Thankfully, credit card companies must be transparent about APR and other terms. You can easily find your APR by:
- Checking your monthly statement online or on paper
- Looking at your account agreement that came with your card
- Calling the number on the back of your card and asking directly
Armed with the knowledge of how credit card APR works, you can now make informed decisions to keep interest costs low. Pay close attention to APR when applying for new cards or requesting lower rates from your issuer. Avoid painful credit card interest by paying balances off in full each month.