If you’re like millions of credit card holders, you’ve probably seen the phrase “annual percentage rate” or “APR” on your monthly statement, but you may not truly understand what an APR is, or know how it’s calculated. Fortunately, it’s not difficult to understand—and knowing what an APR is can help you make more informed credit card decisions.
You see the number on your statement and when you’re looking for a new credit card, but what do you really know about APR? Is it different from an interest rate? Do you know what makes an APR? Do you know how the monthly interest is calculated on a credit card?
Technically speaking the APR, or Annual Percentage Rate is a numeric representation of your interest rate. When deciding between credit cards, the APR can help you compare how expensive a transaction will be on each one. Here’s how it works:
Some credit card companies offer a grace period for new purchases, which means that 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 $0 interest. However, if you opt to carry a balance on your card, you pay the agreed upon interest on your outstanding balance.
Many variable interest rates start by using an index, such as the U.S. Prime Rate, and then add a margin. The result is the APR. Here's an example of how the rate is set:
The U.S. Prime Rate, as published in the Wall Street Journal
The margin the bank charges.
* Please note that variable rates can change if the index changes. Additionally, some banks offer a non-variable APR as well.
Banks use a formula to determine how much interest you owe on your outstanding balance. They calculate using a daily or monthly periodic rate, depending on the card.
APR / 365 days = DPR Daily Periodic rate
(DPR x days in billing period) x Balance Subject to Interest Rate = Interest charged
Keep in mind that some accounts have multiple APRs, so this calculation may be applied for each one. The statement gives you more information about how to calculate the Balance Subject to Interest Rate.
There are different APRs based on how you use your credit card. Keep in mind these rates and your credit needs when selecting a card.
The rate applied to credit card purchases.
The cost of borrowing cash from your credit card, this APR tends to be higher. There may be a different APR for Balance Transfers, checks or certain types of Cash Advances. No grace periods.
Usually the highest APR. It may be applied to certain balances when you violate the card terms and conditions like failing to make payments on time.
Features a lower APR for limited time period. It can apply to specific transactions as well as balance transfers, cash advances or any combination.
Before you get any credit card, keep in mind that: