When you review your monthly credit card statement, you’ll see references to APR. If you look closely, you might notice that the APR for purchases and balance transfers is different to the one for direct deposits or cash advances. So what is credit card APR and why is it important?
APR stands for annual percentage rate, which simply means interest on some type of credit account. With a credit card, APR generally refers to the interest applied to your account during a given billing cycle. It most often comes into play when you carry a balance, but other transactions—like cash advances and late payments—are also subject to APRs, which might be higher than your regular rate.
Credit cardholders should know how APR works, when it might apply to them and, most importantly, how good financial habits can help them avoid it.
How APR works
This is how APR is calculated for credit cards:
- It starts with calculating your daily percentage rate. This is found by dividing your credit card’s purchase annual percentage rate by 365 (the number of days in a year). For example, if your APR is 18 percent, your daily rate is .00049 percent.
- Then, add up your balances at the end of each day in the billing cycle and divide the sum by the number of days in the billing cycle. This is your average daily balance.
- Your daily rate is then multiplied by your average daily balance and that number is multiplied by the number of days in the billing cycle. With most issuers, the interest compounds daily.
So the formula looks like this: daily rate x average daily balance x days in billing cycle = credit card interest
How much APR could cost you
The good news is that this interest doesn’t get charged to your account if you keep your balance paid in full and on time every month. You also have the benefit of a grace period that starts at the end of the billing cycle and usually lasts 21 days, a period of time when you can pay off your new balance without facing interest charges.
However, if you do carry a balance on your credit card, you will owe interest (you’ll also lose your grace period for the next several months, even if you only carry a balance for one month). How much depends on your card’s APR, the size of your balance and the size of your monthly payment. You can use Bankrate’s Credit Card Payoff Calculator to get an idea of how much APR could cost if you carry a balance and make only partial monthly payments.
Experian reports that the average American’s credit card balance in 2020 was $5,315. Bankrate estimates the current average credit card interest rate at around 16 percent. Using a range of APRs and a minimum monthly payment of 3 percent of the balance, and assuming no additional charges are made on the card, here are some scenarios from the credit card payoff calculator:
|Minimum monthly payment (3%)||Repayment timeline||Total interest charges|
|$5,315 at 12% APR||$159||41 months||$1,186|
|$5,315 at 16% APR||$159||45 months||$1,768|
|$5,315 at 24% APR||$159||56 months||$3,551|
What are the different kinds of APR?
The APR that most people are familiar with is the purchase APR. However, there are several types of APR that could apply to your credit card. Here are the main variations that you should be familiar with.
- Purchase APR: This is the interest rate applied to all purchases made with your card. Any time you use your card to buy something, whether online, in person or over the phone, this amount will be applied.
- Introductory APR: Credit cards with introductory APR offers provide a promotional interest rate for a limited period of time that is lower than the card’s regular APR, sometimes as low as 0 percent. It can apply to purchases or balance transfers or both. Once the introductory period expires, the regular APR will apply to your balance.
- Cash advance APR: When you borrow cash on your credit card your withdrawal will be subject to the cash advance APR. This rate is typically higher than your purchase APR and doesn’t have a grace period. It’s also the rate usually applied to convenience checks.
- Penalty APR: This applies to missed or returned payments and could go as high as 29.99 percent. You might have to make several consecutive on-time payments before your credit card issuer removes the penalty APR. A payment more than 60 days past due could result in the penalty APR applying to your current balance, as well.
Fixed APR vs. variable APR
Another important aspect of credit card APR is that the rates can be fixed or variable. With credit cards, variable rates are far more common than fixed rates.
A fixed APR rarely changes, except in the case of a late payment or the expiration of an introductory offer. The benefit of a fixed rate is that your rate is locked in for a period of time. It makes planning for your payments easier because you know the rate will generally stay consistent. However, card issuers can change a fixed rate at their discretion, though they’re required to provide notice.
But more often than not, your credit card will have a variable APR that covers a certain range, such as 15.49 percent to 25.49 percent. A variable APR changes according to the prime rate, a bench mark that lenders use to determine interest rates on credit cards as well as other credit accounts, such as loans and mortgages. While a variable rate may not offer the predictability of a fixed rate, it offers the possibility of paying less.
Learn more: How to lower credit card interest rates
What is a good credit card APR?
A good bench mark to use when judging APRs is the average rate, which currently hovers around 16 percent. How your credit card APR compares to the average depends on factors, including your credit score and what type of credit card you have.
If you have a lower credit score, your APR is likely to be higher. With a higher credit score, your APR is likely to be lower. By improving your credit, you increase your chances of scoring a lower interest rate.
The bottom line
Your APR is a key part of understanding your credit card bill. If you don’t plan to carry a balance on your credit card, you won’t have to worry about it too much. However, if you are among the people who do carry a credit card balance, understanding your APR will make budgeting for your monthly credit card payments much easier.