Understanding Credit Card APRs & Interest Rates

Understanding Credit Card APRs & Interest Rates

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The Annual Percentage Rate (APR) is the interest that you must pay for borrowing money from your financial institution. The language surrounding APRs is everywhere – in offers that you see on billboards and that you receive in the mail. However, it can be puzzling 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.

What is the meaning of "APR"?

As previously mentioned, APR stands for "Annual Percentage Rate" — the rate that you are charged per year for carrying a balance. APRs and interest rates are not 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.

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.

Purchase APR. 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.

Balance transfer APR. If you move or transfer a balance from another card onto your credit card, you will be charged this APR. While uncommon, it is possible for the balance transfer APR of a card to be greater than the purchase APR.

Penalty 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. The typical penalty APR is 29.90%. This number is no coincidence – banks are not allowed to charge higher than this. Note, not every credit card has a penalty APR — you should review your card's terms and conditions to see if it includes one.

Cash advance APR. If you use your credit card to get funds (via an ATM withdrawal, etc.), you will often be charged a separate APR for your cash advance. While usually not as high as a penalty APR, cash advance APRs tend to be greater than purchase/balance transfer APRs. What makes cash advances especially dangerous is that they generally don't have a grace period. You start building interest the day you take a cash advance out.

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.

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 loans like 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 student loans.

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 'Pricing & Condition' 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 a lower APR. Below you can see a sample credit card agreement; the APR section is usually listed first.

How do credit card companies determine their APRs?

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. If the Federal Reserve chooses to raise the Prime Rate, it is possible (and likely) for your credit card APR to 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 low interest rates, while cards with rewards programs tend to have higher APRs. Here is the average APR by card type:

Credit card typeLowHighOverall
Travel rewards cards15.27%23.30%19.29%
Airline15.95%24.16%20.06%
Hotel15.58%23.99%19.79%
Business credit cards13.33%20.08%16.00%
Cashback credit cards15.03%22.18%18.61%
Student credit cards15.26%21.66%18.46%

How to calculate credit card interest

To calculate credit card interest for the month, you must 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.

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 will not accrue interest as long as you pay your statement balances in full.

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%. 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.
  • If the card issuer is in a weak financial position.
  • Because your issuer wants to.

According to the CARD Act, issuers are not allowed to raise the APR if you've had your card for less than a year. The only exceptions are if you are 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 and 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, if you are using a 0% balance transfer deal and make a new purchase with the card, your payment will be applied to the transferred balance first. You will be charged interest on any new purchases you make with the card as they are not subject to the 0% balance transfer offer. Only the amount transferred qualifies for 0% during the promotional time period.

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 re-evaluate your rates. While you may not get the same APR that you had before your late payment, your bank may lower it for you.

Why is paying interest a bad deal?

By paying interest, you are paying more for items than they are worth. 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 are done paying off the TV, you paid $200 in interest, that purchase has ended up costing you $5,200.

It is important that we understand the true cost of the items and services we purchase – otherwise, we might end up spending more than we otherwise 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 rarely worth more than what you paid for them. Therefore, paying interest on top of that price is a bad deal.

Brett Holzhauer

Brett Holzhauer is ValuePenguin’s travel rewards expert, focusing on credit card rewards maximization, consumer travel trends, and personal finance news. He has earned and burned over 5 million points and miles throughout his travels, saving him roughly $75,000 in travel expenses.

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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).