Understanding Credit Card APRs and Interest Rates
Understanding Credit Card APRs and Interest Rates
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Language surrounding annual percentage rate (APR) is everywhere, most often in offers that you see on billboards and receive in the mail. However, it can be puzzling to figure out how a credit card's APR is calculated.
While you may be familiar with the general rule of the lower the APR, the better, there is much more nuance to this topic.
This guide will walk you through everything you need to know about credit card APRs.
Table of contents
- Credit card APR explained
- The different types of APRs
- Fixed vs. variable APR
- How do credit card companies determine their APRs?
- What is an average credit card APR?
- How to calculate credit card interest
- How does your APR affect your credit card balance?
- What can increase your credit card's APR?
- How to lower the APR on a credit card
- Why is paying interest a bad deal?
Credit card APR explained
As previously mentioned, APR stands for "Annual Percentage Rate" — the rate you're charged per year for carrying a balance. Know straight away that it shouldn’t be confused with a general interest rate — APRs and interest rates aren’t exactly the same. As the name suggests, your card's APR is an annualized representation of its interest rate — however, most credit cards compound interest on a daily basis.
APR grace period
Banks usually include a so-called "grace period" in your card agreement — a time during which you can pay off your balance without getting charged interest. As noted previously, most banks charge interest on a daily basis, using a method called average daily balance. If you pay off your balance during the grace period, which is usually around 25 days, you won't owe interest on that balance. This is why we recommend you always pay off your balance by your due date.
The different types of APRs
If you’ve looked at the terms and conditions of a credit card, you’ll notice that there are a number of different APR rates.
This is the APR applied to all purchases you make with your credit card. This is the most common interest rate, and the one we tend to think of first when looking at credit cards.
If you move or transfer a balance from another card onto your credit card, you'll be charged this APR. While uncommon, it is possible for a card’s balance transfer APR to be greater than its purchase APR.
If you become delinquent in credit card payments — that is, if you don’t pay the minimum amount due for more than 60 days — you may trigger a penalty APR. Penalty APRs are usually significantly higher than the regular purchase APR, typically around 29.90%. This number is no coincidence — banks aren't allowed to charge any higher than this. Note that not every credit card has a penalty APR — you should review your card's terms and conditions to see if it includes one.
If you use your credit card to get funds (via an ATM withdrawal, for example), you'll often be charged a separate APR for your cash advance. While not usually as high as a penalty APR, cash advance APRs tend to be greater than purchase and balance transfer APRs. What makes cash advances especially dangerous is that they generally don't have a grace period — instead, you start building interest the day you take a cash advance out.
Some credit cards offer a 0% intro APR when you first open your account. These 0% intro APR cards can be very beneficial for those intending to make a large purchase on their card (and could likely use a bit of leeway paying down their debt). While this can be a nice sign-up perk, be wary that when your intro rate ends, the regular purchase APR will apply.
Fixed vs. variable APR
There are two different types of APRs that are mentioned often — fixed and variable.
A fixed APR is a rate that stays constant throughout the life of the loan or agreement. These are regularly seen with products such as mortgages and car loans.
A variable APR is a rate that fluctuates, depending on a few different factors. The entire percentage is determined by:
- The base rate and margin from the credit card issuer (this comes from the issuer evaluating your credit history)
- A change in the federal prime interest rate
A variable APR can change at any moment, without any notice. These types of rates are regularly associated with credit cards and private student loans (federal student loans offer fixed rates).
How do credit card companies determine their APRs?
Your credit card APR is based entirely on what your bank calls "creditworthiness" — in other words, your FICO Score. Most "Terms & Conditions" disclosures have a list of several different APRs for purchases. Those represent the range of interest rates you may be charged, depending on your score. Generally, higher FICO Scores correspond with lower APRs. Below you can see a sample credit card agreement; the APR section is usually listed first.
Keep in mind that banks can raise or lower your APR without any notification. You should also note that variable APRs are based on the Prime Rate. This figure is decided by the U.S. Federal Reserve — so if the Federal Reserve chooses to raise the Prime Rate, it is possible (and likely) that your credit card APR will follow suit.
What is an average credit card APR?
Credit card interest rates vary greatly between different issuers, brands and credit card types. Some credit cards are designed specifically to have lower interest rates, while some cards with rewards programs tend to have higher APRs.
Here is the average APR by card type:
Credit card type | Low | High | Average |
|---|---|---|---|
| Travel rewards cards | 15.26% | 23.35% | 19.31% |
| Airline | 15.99% | 24.26% | 20.13% |
| Hotel | 15.67% | 23.99% | 19.83% |
| Secured credit cards | 22.39% | 22.39% | 22.39% |
| Cashback credit cards | 15.08% | 22.35% | 18.72% |
| Student credit cards | 15.79% | 21.79% | 18.79% |
How to calculate credit card interest
To calculate your credit card interest for the month, use the following formula (with a few variations included):
Total credit card interest for month = Balance x Daily Periodic Rate x Number of days in billing cycle
The key figure used in calculating your monthly interest is called the Daily Periodic Rate (DPR). To obtain your DPR, you simply divide your APR by the number of days in a year.
Total Interest = Balance x (APR / 365) x Number of days in billing cycle
The number of days in a billing cycle represents the number of days between bills. This number changes with the number of days in a month.
The term "balance" represents several different terms, like "average daily balance" or "adjusted balance." Different financial institutions have different ways of calculating that balance — the two methods we mentioned here are the most common. Average daily balance is calculated by adding up your balance at the end of each day, then dividing the sum total by the number of days in the billing cycle.
Total interest = Sum of daily balances X (APR / 365)
If your balance has more than one APR, the result is a little more complicated. Total interest in that case is the sum of the above formula, for each individual APR and balance.
Example:
Say you have an APR of 15%, and a balance of $5,000. In that case the average daily interest paid will be: ($5,000) x (0.15/365) = $2.05. From here, you can multiply $2.05 x 30 to find your monthly interest accrued, which is $61.50.
Keep in mind that you won't accrue interest as long as you pay your statement balances in full each month.
How does your APR affect your credit card balance?
When you pay your credit card bill, your payment is applied to your balance in a certain order, determined by APR:
- The minimum payment is usually applied to the lowest APR balance.
- Any amount greater than your minimum payment goes toward the highest balance.
For example, imagine that your total outstanding credit card balance is $1,000, with a minimum payment of $100. Of that balance, $500 is accumulating 15% interest, and the other half has an interest of 24%, as this is partly a cash advance balance and partly a regular purchase balance. If you write a check for $500 to your bank as payment, $100 will go toward paying the 15% balance, while the other $400 will pay down the 24% balance.
What can increase your credit card's APR?
There are several reasons why a credit card APR may increase suddenly:
- You miss a payment on your credit card
- A promotional rate ended
- The Prime Rate mandated by the federal government increases
- Your credit score goes down
- The card issuer is in a weak financial position
- Because your issuer wants it to
According to the CARD Act, issuers aren't allowed to raise the APR if you've had your card for less than a year. The only exceptions are if you're more than 60 days late on payments or the prime rate increases.
It is worth noting that consumers must be given 45 days notice of an APR change. You have the right to opt out, which will result in the card being closed; in this case, any outstanding balances will need to be paid.
How to lower the APR on a credit card
You can consolidate your credit card debt by moving your balance due over to a 0% intro APR balance transfer credit card. These cards are specifically designed to help consumers pay down debts. The best balance transfer credit cards will offer a 0% APR for 15 to 21 months, from the time of purchase. Note that if you're using a 0% balance transfer deal and make a new purchase with the card, your payment will be applied to the transferred balance first. If the card doesn’t also offer a 0% rate on purchases as well as transfers (which many do), you'll be charged interest on any new purchases you make with the card, as they aren't subject to the 0% balance transfer offer. Balance transfer fees may apply.
If your APR was raised because of a late payment, it doesn’t have to stay high. If you have been making at least the minimum payment for several billing cycles, and your credit score has improved, you can formally request that your bank reevaluate your rates. While you may not get the same APR that you had before your late payment, your bank may still lower it for you.
Why is paying interest a bad deal?
By paying interest, you're paying more for items than they’re worth. For example, if you bought a TV for $5,000, you probably did so because you considered it to be worth $5,000. However, if by the time you're done paying off the TV, you paid $200 in interest, that purchase has ended up costing you $5,200.
It is important to understand the true cost of the items and services you purchase — otherwise, you might end up spending more than you would have.
This is why we urge our readers to pay off their credit card balances in full — before interest is charged. Small purchases like clothing, meals and movie tickets are also rarely worth more than what you paid for them. Therefore, paying interest on top of that price is a bad deal in every case.
Frequently asked questions
Your credit card APR is the amount of interest you'll be required to pay if you don't pay off your balance in full each month. This percentage typically ranges from around 12% to 26% depending on a variety of factors, including your credit score and the type of credit card you have.
If you pay your credit card bill off on time and in full every month, your APR won't apply. If you pay your bill on time but not in full, you'll be charged interest on your remaining balance.
Yes, you'll get charged interest if you only pay the minimum required amount of your monthly bill — however, the interest will only be charged on the remaining unpaid amount, not on the entire original balance before payment.
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How We Calculate Rewards: ValuePenguin calculates the value of rewards by estimating the dollar value of any points, miles or bonuses earned using the card less any associated annual fees. These estimates here are ValuePenguin's alone, not those of the card issuer, and have not been reviewed, approved or otherwise endorsed by the credit card issuer.
Example of how we calculate the rewards rates: When redeemed for travel through Ultimate Rewards, Chase Sapphire Preferred points are worth $0.0125 each. The card awards 2 points on travel and dining and 1 point on everything else. Therefore, we say the card has a 2.5% rewards rate on dining and travel (2 x $0.0125) and a 1.25% rewards rate on everything else (1 x $0.0125).