What is APR?
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Key takeaways
- APR, or annual percentage rate, represents the annual cost of borrowing money, including fees, expressed as a percentage; for credit cards, APR is generally just interest
- Understanding a credit card’s APRs, including how they are calculated, can help you compare offers and find the right card for you
- A good credit score may help you get a lower APR on a new credit card
You may have seen the term APR, or annual percentage rate, used in reference to everything from mortgages and auto loans to credit cards. Understanding how banks calculate APRs and how they work can help you make more informed credit card decisions. Here’s what you need to know.
How does an APR work?
APR stands for Annual Percentage Rate and it represents the yearly cost of borrowing money. It includes the interest rate that applies to your account (credit card, mortgage, line of credit, etc.) plus other fees related to that account.
Generally, credit card companies won’t charge interest on purchases if you always pay your entire outstanding balance by the payment due date.
However, if you carry a balance, each purchase will usually begin accruing interest on the day the transaction is made and is added to your outstanding balance at the end of each billing period.
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How to calculate interest charges on a credit card
The formula to determine how much interest you owe on your outstanding balance may vary by creditor, but generally works like this:
Let’s say your credit card’s APR for purchases is 17 percent, and your average daily balance for purchases during a 25-day billing cycle is $2,000.
First, determine your daily periodic rate by dividing the APR by 365 days.
17%
Card’s APR
365
Days
0.0466%
Daily periodic rate
Next, multiply the purchase balance by the daily periodic rate and that result is then multiplied by the number of days in the billing cycle.
$2,000
Average daily balance
0.0466%
Periodic daily rate
25
Days in the billing cycle
$23.30
Monthly interest charge
So, if these numbers applied to your credit card account, you would owe $23.30 in monthly interest.
Keep in mind that your account may have multiple APRs (one for purchases, one for cash advances and one for balance transfers). Check your monthly statement and cardholder agreement for additional information on how each APR is applied.
Types of APR explained
For credit cards, the APR is generally just the interest rate that applies to your account. Credit cards may have either fixed or variable APRs and will usually have different APRs that apply to different types of transactions (purchases, balance transfers, cash advances) or when there is a default under the terms of the credit card agreement (penalty). There may also be introductory or promotional APRs which are limited offers that will apply to certain transactions over a specific period of time (for example, 0% APR on purchases for 12 months).
Here’s a look at some of these terms:
A rate that isn’t variable – meaning that it won’t increase or decrease based on changes to an underlying index rate, such as the U.S. Prime Rate, but that doesn’t mean that the rate will never change. Certain events, like late payments or violating the terms of your credit card agreement, may cause that rate to change.
A rate that will increase or decrease based on the movement of an index rate, such as the U.S. Prime Rate. For credit card accounts, the rate will include an index plus some type of margin or percentage added to the index.
The rate that will apply to credit card purchases.
The rate for borrowing cash from a credit card, which is generally a higher rate than the rate for purchases.
The rate for transferring a balance from one account to another.
The rate applied to balances on an account, as a result of late payments or violating certain terms of the credit card agreement.
Typically, a lower APR than the standard APR on an account, which is offered for a limited time (for example, six months or a year) and will apply to certain transactions (for example, purchases or balance transfers).
How to get a lower interest rate on a credit card
One of the most important things you can do is maintain a good credit score. Credit card issuers take into consideration many different factors, including your credit score, in evaluating an application and determining the APRs that will apply. Paying your bills on time, not letting your accounts get close to their maximum credit limits, and monitoring your credit reports are just some of the ways you can help maintain or improve your credit score.
Generally, people with better credit scores tend to get better rates than people with lower credit scores.
Remember, while APR is important, it’s just one of the factors to take into account when choosing a credit card that’s right for you.
