What are the different types of credit card APR?
Annual Percentage Rate, or APR, is key to understanding the full cost of borrowing when applying for credit. This percentage represents the annual interest rate that a lender charges over the term of a credit agreement. Along with the interest rate, APR also includes any applicable fees, such as origination fees on loans.
Understanding how lenders calculate and apply APR to transactions can give you a clearer picture of the price you’ll pay for borrowing. It also makes it easier to compare your credit options and make more informed decisions.
How is APR calculated for credit cards?
You will not have to pay any interest on your credit card if you clear the balance in full within the grace period each month. If you carry a balance forward into the next billing cycle, interest charges will apply to the outstanding balance on your account.
Lenders use a formula to determine how much interest you are due to pay. They calculate this on a daily or monthly periodic rate, with different rates of interest applying for various transaction types.
You can work out how much interest is due on your balance by dividing the APR by 365 (the number of days in the year) to calculate your daily periodic rate (DPR). The credit issuer will multiply your current balance by the DPR to determine the daily interest charge. This interest is then compounded until you repay the outstanding balance in full.
Variable APR vs fixed APR
Most credit cards will have a variable APR. This means that the rate of interest depends on the U.S. prime rate as published in the Wall Street Journal and can fluctuate. The variable APR will change if the index changes.
Lenders add their margin to the prime rate to determine APR. This margin is around 14% on average. For example, if the prime rate is 4% and the lender’s margin is 14%, your APR will be 18%. The prime rate is the lowest APR that lenders can charge their most creditworthy borrowers.
It is rare for credit cards to have fixed interest rates. A fixed APR means that the rate of interest remains the same despite changes in the market. Lenders can change their fixed APR, but they must give written notice and changes cannot be applied retrospectively.
The different APRs that apply to credit cards
Different APRs can apply to the same credit card, depending on transaction types and promotional offers. Make sure you understand all the APRs you may be subject to when using your credit card.
- Purchase APR: This is the rate applied to purchases made on your credit card if you carry a balance forward into the next billing cycle. It is the most common APR type that you will see on your credit statement.
- Promotional APR: Many lenders offer lower APRs to new customers for a short period. It can apply to new purchases made during the introductory period, as well as other types of transactions like cash advances and balance transfers.
- Cash Advance APR: Higher rates of interest will apply for cash advances, along with additional fees. There will also be no grace period, so interest will accumulate immediately on this type of transaction.
- Penalty APR: Your credit card issuer can charge the highest APR outlined in your credit agreement for violations against the terms and conditions. This includes exceeding the credit limit or multiple late payments. On average, penalty APR is around 29.99%, with no legal limit on the rate lenders can charge.
What affects the rate of interest lenders offer you?
Not every borrower will get the same APR on their credit card. Lenders determine interest rates based on several factors, including your current financial situation and credit score. If you have a higher credit score, you’re more likely to get lower rates of interest.
While APR is a useful way of comparing credit offers, it’s also important to consider other factors too. These include the credit limit, promotional offers and any reward programs. This way, you can ensure you choose the credit card that is most suitable for your needs.