A Simple Guide to Understand Your Credit Card’s APR
In your search to find the ideal credit card for your spending habits and financial needs, there are all sorts of factors that you likely pay close attention to. You may be draw in by a signup bonus or focus heavily on the rewards program that the card offers. But, one detail that you definitely don’t want to overlook is the annual percentage rate (APR) associated with the card.
Most people have seen the term APR before but not many know the ins and outs of it and how the value impacts their monthly payments and fees. To empower yourself as a credit cardholder, we’ve created a simple guide to help you better understand your credit card’s APR.
Continue reading to learn about when interest is charged, how it’s calculated, and what factors play a role in the APR you receive.
Understanding When Interest is Charged
A perk that not many card holders know about is that most credit cards come with a grace period. Grace period includes the time when your credit card statement period ends to when your payment is due. The total number of days depends on the card issuer but at minimum, you can expect to have a grace period of 21 days.
During the grace period, if you pay the entire balance before the grace period ends, you aren’t charged any interest and the APR credit card number doesn’t much matter! But, if you only pay a portion of the total statement balance before the due date, interest will accrue on the purchases you’ve made.
Since grace periods can be card issuer dependent, be sure to read the fine print to determine if the card offers an interest-free period or not.
How Interest is Calculated
If you are paying off your balance each month, you don’t need to worry much about how interest is calculated. But, if you will be carrying a balance on the credit card, you’ll see a line for interest payment on your monthly statement. While the credit card company crunches the total interest charged, it doesn’t hurt to know how the figure is derived.
First, even though APR stands for annual percentage rate, it’s not calculated on a yearly basis. Instead, it’s actually calculated on a daily basis. This daily number is known as the periodic interest rate. To get this number, you can do some simple math.
Let’s assume you have a credit card with an APR of 15%. To determine the periodic interest rate, you would divide the APR (15), by the number of days in a year (365). Note that some card issuers use 360 days versus 365. In the first instance, the periodic interest rate would be 0.04109%. In the second instance, the rate would be 0.04166%.
While these numbers are quite small, over time, the total interest charge can really add up, especially if the card has a high balance.
Once you know your periodic interest rate, you then need to find out the daily basis on the card. Let’s say you have a $1,000 balance on the card at the beginning of the month. On the 16th you’re able to make a payment of $250, and then on the 25th you pay another $250, bringing your end balance down to $500. In this scenario, your daily average balance would be $825.
With your daily periodic interest rate and your daily average balance, you can multiply them together to determine your monthly interest fee, which would be $10.15.
Factors that Affect APR
There are many factors that can impact a credit card’s APR. Most credit card issuers offer variable APR, which means that the rate can increase or decrease depending on various factors. Some of these factors you can control while others are out of your hands.
Due to the CARD Act, anytime your APR rate will change, the credit card company will notify you 45 days ahead of time.
One of the biggest factors that impacts APR is your credit score and credit history, best summed up as your credit worthiness. When applying for a credit card, the issuer wants to ensure that you can pay back the money you borrow. Credit card companies may also look at your FICO score and other credit scores.
The higher your scores, the lower your APR will be. If you have a low credit score, you can expect to be approved for a high APR.
Another factor that impacts APR is the prime rate. This number is the lowest rate of interest in which people can borrow in the commercial world. When the Federal Reserve increases or decreases its rates, your APR can be impacted. If the Federal Reserve increases rates, your APR may go up, and the same stands for if the rates are decreased.
Having a thorough understanding of what APR is, how it works, and the factors that impact it empower you as a cardholder. In turn you can make better payment ideas or ensure that the new credit card you’re applying for is best for you.