What is APR?
Read, 3 minutes
- APR, or annual percentage rate, represents the yearly interest charged on loans
- Use APR to help evaluate the potential costs of credit cards and other loans
- Federal consumer law requires lenders to disclose APRs
- A good credit score can help you get a lower APR
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 APR work
Generally, credit card companies offer a grace period for new purchases. If you only make purchases and pay off your ending balance each month by the due date, you pay just the amount you owe with no interest. However, if you carry a balance on your card, the agreed-upon interest is added on to your outstanding balance at the end of each billing period.
How banks calculate APR
Though credit card APRs can vary significantly, almost all start with the U.S. Prime Rate, which is the financial institutions charge their customers for lending products. Credit card issuers add a small fee on top of that, called a margin, to the prime rate to get the APR. That margin varies depending on the type of card, the cardholder’s and how the card is used. It’s important to understand that economic conditions can cause the prime rate to fluctuate. That means APRs tied to the prime can change as well. Some banks offer fixed-rate credit cards, so the APR won’t fluctuate with changes to an index rate.
Did you know?
In most cases, lenders cannot change the APR for the first 12 months you have the card but be sure to read the fine print before opening a new account. Exceptions may include promotional or variable rates or if the card’s terms and conditions are violated.
How to calculate your credit card interest
The formula to determine how much interest you owe on your outstanding balance varies by bank, but generally works like this: Let’s say your card’s APR is 17 percent, and your average daily balance during a 25-day billing cycle is $2,000.
Find your daily rate by dividing the Annual Percentage Rate by 365 days.
Your card’s APR
Your daily rate
Multiply the daily rate by the days in the billing cycle and the balance.
Your card’s daily rate
Days in the billing cycle
Your monthly interest charge
Keep in mind some accounts have multiple APRs, so this calculation may be applied for each one. Check your monthly statement and cardholder agreement for additional information on how each APR is applied.
Types of APR explained
Your credit card has based on how you use it. When you’re selecting a credit card, it’s a good idea to consider these rates in addition to your credit needs. The different APRs include:
The rate applied to credit card purchases.
Usually the highest APR. It may be applied to certain balances when you violate the card terms and conditions, such as failing to make payments on time.
Introductory or promotional
Typically, a very low rate offered for a limited time. It can apply to specific transactions, as well as balance transfers, cash advances or any combination.