As a credit cardholder, you’ve likely come across the term “annual percentage rate” (APR) at some point. But even if you have a rough idea of how APR works, you may still have questions about it. Understanding credit card APR is crucial for managing your finances effectively and avoiding unnecessary costs. In this guide, we will demystify credit card APRs and how they work, including what APR really means, how credit card companies calculate interest on your account, and how you can avoid paying credit card interest.
What is APR on a credit card?
APR stands for annual percentage rate, which represents the yearly cost you pay to borrow money from a lender or credit card issuer. With installment loans, like personal loans or auto loans, APR includes both the interest and fees that a lender may charge. However, credit card APR does not include annual fees. In the case of credit cards, APR just stands for the yearly interest rate.
There are different types of APR that you might encounter as a credit cardholder. The most common type is the Purchase APR, which is the interest rate applied to purchases made with your card. This rate can be fixed or variable, meaning it can stay the same over time (fixed) or change according to the prime rate (variable). Other types of APR include Introductory APR, Cash Advance APR, and Penalty APR, each serving different purposes and having different rates.
What is a good APR?
The average credit card APR exceeds 20% according to the Federal Reserve. By that measure, credit card APRs are significantly higher than other forms of consumer credit, including some personal loans and auto loans. A good credit card APR may be one that’s under 20% or the lowest APR you can find. Generally, interest rates are very high right now due to various macroeconomic factors, so finding a low APR can be challenging.
How to calculate APR on a credit card
To understand how credit card companies calculate credit card interest, you need to be familiar with a few terms. The daily interest rate is calculated by dividing your APR by 365, and compounding interest is when the issuer multiplies your daily rate by your balance. The average daily balance is calculated by adding your daily balances and dividing by the number of days in the billing cycle. By using these figures, you can calculate the credit card interest you’ll pay in a billing cycle.
To illustrate how credit card APR works, let’s consider an example. Suppose your credit card APR is 18.25% and your average daily balance is $1,000. With a 30-day billing cycle, you would pay $15 in interest charges. This calculation shows how quickly interest charges can add up if you carry a balance on your credit card.
How to avoid paying interest on credit cards
The best way to avoid paying interest on your credit card is to pay your full statement balance by the due date of every billing cycle. By doing so, you can take advantage of the grace period between your statement closing date and the due date to avoid interest charges. It’s essential to pay off your balance during this period to prevent accruing interest on your account.
Paying your credit card balance off early, before the statement closing date, can also help lower your credit card utilization and improve your credit score. However, if you struggle to pay off your balance every month, paying attention to your credit card’s APR is crucial. High APRs can lead to significant interest charges, so it’s essential to have a plan in place to manage your credit card debt effectively.
In conclusion, understanding credit card APR is essential for managing your finances and avoiding unnecessary costs. By knowing how APR works, the types of APR you might encounter, and how to calculate interest charges, you can make informed decisions about your credit card usage. Remember to pay your full statement balance every month to avoid paying interest and consider creating a plan to pay down your credit card debt quickly. By following these tips, you can make the most of your credit card benefits while minimizing costs and maximizing financial stability.