What is a Credit Card APR?

The initials APR always show up in conversations about most forms of borrowing, including mortgages, auto loans, and credit cards. So what exactly does it mean? The letters stand for Annual Percentage Rate, which is the yearly rate of interest a lending institution charges for extending a loan. 

At this point, you’re likely asking, “So how does a credit card APR work?”

Good question. Let’s delve into the subject.

How Does a Credit Card APR Work?

Most credit cards offer a window of time (also known as a grace period) between the date a purchase is made and when the payment becomes due. So long as you pay before the end date, you can pay off that month’s charge at face value. In other words, if you use your credit to make purchases over the course of a month and pay off the balance before the due date, you’ll only pay the amount you borrowed, with no interest charges. 

The due date is based on the length of the billing cycle the card issuer employs. This can vary from 28 to 31 days and is disclosed on the card issuer agreement. It can also be found on the monthly statements card issuers must provide. 

Should a portion of the amount owed be carried over into another billing cycle, interest charges will be applied to that amount. The APR (annual percentage rate) disclosed when on the cardholder agreement determines the rate at which those charges will be applied. 

How Credit Card APRs Are Determined

The interest rate applied to credit card purchases varies from card issuer to card issuer. They can be as low as 0% (for a limited-time special offer) to as high as the card issuer thinks the market will bear. There is no legal limit governing the APR credit card companies can charge. With that said, the average (as of this writing) is around 24.16%, according to Forbes Advisor’s weekly credit card rates report

It should also be noted that a number of different factors go into the determination of an APR for every credit card customer. One of the most prominent considerations is the cardholder’s credit history. Those with a track record of meeting financial obligations in a timely manner usually enjoy lower APRs than customers whose histories reflect late payments.

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APRs Can Vary

Credit card APRs can also vary according to the type of transaction. Purchases typically carry the lowest rates, while balance transfers and cash advances generally carry higher rates. Missing a payment or making a late payment can also cause a credit card’s APR to rise.

Some issuers offer very low, or even no-interest deals on certain types of transactions for a specified period. These are usually part of a balance transfer offer, designed to get customers to move balances from one card issuer to another. Before you transfer your balances, it is important to know the fee, if any, that you will be charged.

Some credit cards have fixed rates, which means the APR will remain the same (as long as the customer meets the requirements of the cardholder agreement). Other cards have variable rates that fluctuate along with the prime interest rate. Many people today with variable rates or who are carrying monthly balances are feeling the effects of inflation through skyrocketing rates.

Calculating Credit Card APR

The annual percentage rate can also be broken down to determine the daily interest rate card issuers impose. This becomes important when paying off a credit card balance in full. Since interest on outstanding balances is charged on a daily basis, it is important to contact a card issuer to see what the actual payoff amount would be on that particular day.

To find the daily rate, divide the stated APR by 365. Multiply that number by the average daily balance being carried. Then multiply that result by the number of days in the billing cycle. That is the daily rate. 

For instance, a card with a 22% APR would have a daily rate of .06%. Carrying an average daily balance of $100 over a 28-day billing cycle would return a charge of $1.68 in interest for that particular month.

APRs Compound

Another important factor of which to take note of is that interest on credit card debt compounds daily. Carrying a balance over into a second billing cycle will cause the accumulated daily interest amount to be added to the outstanding balance. The following month, interest charges would again be added to the carried-over balance, and so on. 

This is how unresolved credit card debt can get out of hand and why cardholders should always make more than the minimum payment on their debt. 

Credit card minimum payments are calculated by issuers specifically to keep balances due for as long as possible. That way, they can net hundreds of thousands of dollars in interest charges year after year.

The minimum payment amount usually only covers interest charges and a tiny percentage of the principal balance. When this is considered in conjunction with the fact that credit card interest compounds, it becomes easy to see how decades can be required to clear a credit card balance when using minimum payments. 

In Summary

A credit card’s APR can be a useful tool when comparing credit card offers. However, it’s also important to pay attention to a card’s fee structure, billing cycle, and perks. The main thing to keep in mind here is that the best way to use any credit card is to pay the balance off in full every month before the next billing cycle begins. Do that and the card’s APR becomes irrelevant.

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