What Is APR? What You Need To Know
The annual percentage rate, or APR, is an essential concept for anyone borrowing money to understand. It is the total rate of interest paid annually over the life of a loan. APR plays a vital role in many consumer financial products, such as credit cards, auto loans and mortgage loans. Since credit card APRs are typically much higher than APRs for other types of loans, knowing the APR on a credit card is especially crucial.
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What Is APR?
An APR determines the interest charged on money you borrow for longer than the interest-free grace period, which is usually one payment cycle. Most credit cards, for example, do not charge interest on purchases if the balance is paid in full by the next payment due date. However, that’s not the case with most loans because you repay them over an extended period, during which interest accrues.
Whether for a credit card or a loan, the APR is based on many factors, including the borrower’s credit score and the issuing bank’s policies. A cardholder can find their credit card APR on their statements and in their account disclosure. Loan APRs are listed in the truth-in-lending statement borrowers receive before accepting a loan.
How Does APR Work?
The annual percentage rate represents how much it costs to borrow money. APR includes the interest rate and all fees charged by the lender. It is expressed as a percentage.
A loan issuer — typically a bank — is responsible for setting an APR. Usually, the APR is based on the U.S. prime rate, which is the best rate lenders offer their most reliable customers. Banks then charge a margin of profit on top of the prime rate. Typically, the higher a borrower’s credit score, the lower their APR.
A credit card APR might be 15% or lower for cardholders with excellent credit scores or as high as 30% for those with poor credit scores.
What Is the Difference Between APR and Interest Rate?
APRs and interest rates are related but have slightly different calculations. The interest rate refers to the amount of money the lender charges for the loan. The APR factors in the total cost of the loan.
For example, for a cash advance of $1,000 on a credit card, the card issuer might charge an interest rate of 20%. If the card issuer also charges a cash advance fee of 2%, the APR — the actual cost of borrowing the money — is 22%.
If there are no other fees associated with borrowing money, there is no difference between the interest rate and APR. In most cases, the APR is higher than the stated interest rate for an account.
What Is the Difference Between APR and Effective Annual Interest Rate?
Banks use either a daily or monthly periodic rate for a credit card APR. Dividing the APR by 365 provides the daily periodic rate. Dividing the APR by 12 gives the monthly periodic rate. The lender adds the periodic accrual to the credit card balance. This accrual rate is known as the effective annual interest rate. That rate is the actual interest rate charged on a financial product as a result of compounding the credit over a period of time.
What Is the Difference Between APR and APY?
APY stands for annual percentage yield, and you can think of it as the opposite of APR. Whereas APR represents the interest you pay on debt, APY represents the interest you earn on money you deposit or invest.
When shopping for a credit card or loan, you usually look for the lowest APR because you’ll pay less money to carry the debt. When shopping for a bank account, you look for one with a high APY because you’ll earn more on your account balance.
A borrower will pay more if interest is compounded daily rather than monthly. This difference is important for cardholders who don’t pay off their balance in full each month. Making a partial payment to a credit card balance at the beginning of the billing cycle rather than the end can save on interest if compounding is daily.
What Are the Different Types of Credit Card APRs?
Other types of APRs associated with credit cards are also essential for cardholders to know.
Introductory APR
An introductory or promotional APR is typically offered to a new cardholder for a specified period. This APR is often lower than the regular one, sometimes as low as 0%, and credit issuers often offer it to entice people to apply for a new card.
Balance Transfer APR
The balance transfer APR is a low or 0% APR that applies to balances transferred to the card from another credit card. The rate is fixed for a specified period or until a cardholder fails to make on-time payments. Note, however, that transfers are rarely free — credit card issuers usually charge a fee of about 3%.
Fixed APR
Introductory and balance transfer APRs are typically fixed through the set period. The rate is locked and will not change until the period ends or a cardholder fails to make on-time payments. Most loans have a fixed APR.
Variable APR
Most credit cards have a variable APR. A variable APR changes according to the prime rate lenders charge their best customers. To calculate the variable APR, they add a margin to the prime rate, so a cardholder’s APR may increase if the prime rate increases.
Purchase APR
The purchase APR is the rate used for all purchases other than those made during an introductory period. The purchase APR is typically variable.
Cash Advance APR
Cardholders who borrow cash from a credit card must pay a cash advance APR. It is typically higher than the purchase APR and will apply to the cash advance balance until it is paid off.
Penalty APR
If a cardholder is more than 60 days past due on a payment, the card issuer may apply a penalty APR. A penalty APR may be as much as 29.99% and may apply to all purchases on the card. A card issuer will usually not lower a penalty APR until a cardholder shows a history of on-time payments.
What Is a Good APR?
A good APR is one that is lower than the average interest rate. These APRs are usually reserved for customers with the highest credit scores.
The lowest end of the APR range is a good rate for someone with excellent credit. For example, on a credit card with a variable APR between 13.99% and 28.99%, a 25% APR might be a good rate for someone with fair credit, but it would not be a good rate for someone with good credit. It might not be as good as the lowest rate, but it is lower than what some cardholders with poor credit scores have. This is why it is important to compare credit card APRs before applying for a new card.
How To Calculate Your Credit Card APR
Calculating your credit card APR requires several steps, but it’s worth doing to understand where your money is going. Here’s how to do it, as explained by Chase:
Find your daily periodic rate, which is your daily interest charges. To do that, divide your APR by 365 (or 360, depending on the lender). For example, if your APR is 20%, divide 0.20 by 365. The daily periodic rate in this example is 0.0005.
Calculate your average daily balance. For that calculation, you’ll have to total up every daily balance over a month. Say, for example, you had $100 in charges for the month — $50 charged on Day 1 and $50 charged on Day 16. Multiply each balance by the number of days you had it on your account, and add the amounts together. In this example, that would be ($50 x 15 days) + ($100 x 15 days) = ($750) + ($1,500) = $2,250. To find the average, divide $2,250 by 30 days: $2,250/30 = $75. Your average daily balance is $75.
Next, multiply the daily periodic rate by the average daily balance. In this example, you’d multiply 0.0005 by $75. The product is 0.0375, or 3.75 cents per day in interest.
Now multiply the 3.75 cents by the number of days in the statement month. Assuming that’s 30, you’d multiply 0.0375 x 30. The answer is $1.125 per month in interest.
To calculate your bill, including the charges and interest, add them together. The amount in this example is $101.13 — $100 + $1.125, rounded to $1.13.
Final Take
APR plays a vital role in how much it costs to borrow money. Credit cards can be costly if the APR is high and the balance is not paid off in full each month, so it is essential to know what the APR is on a credit card. Cardholders who get a good APR should be especially careful to always make timely payments. Since credit cards typically have a variable interest rate, a card issuer may raise an APR to a penalty rate if a cardholder is more than 60 days past due on a payment.
FAQ
Here are answers to some common questions about credit card APRs.
What does a 24% credit card APR mean?
A 24% APR is slightly higher than the current national average APR being offered on credit cards.
What is a good APR for a credit card?
The current national average for credit card APRs is around 22.63%. Anything below this rate would be considered good and anything below 10% would be considered a very good APR.
Is an APR charged monthly?
An APR is calculated on an annual basis — it's an annual percentage rate — but it's broken down and applied to your account monthly.
How do you avoid paying interest on your credit card?
To avoid paying interest on your credit card, always pay the amount due on time every billing cycle.
Daria Uhlig and Caitlyn Moorhead contributed to the reporting for this article.
Information is accurate as of April 15, 2024.
This article originally appeared on GOBankingRates.com: What Is APR? What You Need To Know
