APR, or annual percentage rate, is a percentage number that calculates interest on your credit card debt over a period of one year.
Your APR influences how much you owe against your credit card debt. Understanding APR is a big part of using credit cards in a responsible manner.
That being said, there's more to APR than just a simple number. This post will show you why APR is important and how it works.
Why is APR important?
Credit card issuers offer their customers APRs based on current economic factors along with the borrowers' personal financial and credit status. You will find that if you request similar credit cards from multiple issuers at the same time, the APRs you are offered are likely to be in a similar range.
While APR can help you generalize the amount of interest you will pay, it is often an approximate estimate of the amount of interest you will owe. When balances aren't fully repaid, for example, any unpaid interest charges may roll over to the next month's balance - which can start to significantly increase your interest charges.
To get a better understanding of your credit card's APR, take a look at the monthly statement to see how your issuer is calculating APR against your debt. They could use a daily balance method, an average daily balance method, or a number of other interest rate models. Once you understand which method your issuer uses, you can get the fuller picture of how your card's APR works.
Types of Credit Card APR
Below are a variety of APRs that credit card issuers use:
The purchase APR is the rate that will be applied to any purchases made with a credit card.
Cash Advance APR
When you use your credit card to withdraw money from an ATM or other source, you are taking out what's known as a "cash advance" from your credit card. The amount you withdraw with a cash advance will be charged at the "cash advance APR," which is typically a higher rate than the purchase APR.
Penalty APR, as the name suggests, is the rate that will be applied if a payment is late or returned. A penalty APR could be the same or higher than both the cash advance or purchase APR to incentivize you to make payments on time.
Balance Transfer APR
Some credit cards will offer unique APRs when you transfer a balance to the credit card account. This rate is known as a balance transfer APR.
An introductory APR is used when a credit card offers a lower APR during a predetermined period of time or "introductory period." The introductory period starts when you open the credit card and lasts for the predetermined amount of time (usually ranging from 3 to 18 months). Once the introductory period expires, the card's regular APR will start to be applied against any open balance. Credit cards sometimes have introductory APR offers on purchases, balance transfers, or both.
Variable APR vs Fixed APR
A variable APR means that the APR changes with an index interest rate. The prime rate is an interest rate determined by individual banks that some issuers of credit cards will use as a base to calculate their variable interest rates.
A fixed APR generally will not change on a credit provided you make your payments on time. If issuers of credit cards change a fixed APR, however, they typically must notify you in advance before making the adjustment. Fixed APRs are less commonly used for credit cards.
How to get lower APR credit cards
Most credit card companies will calculate your APR based on your credit score and lending history, so if you're having trouble finding a low APR deal on a credit card, you will want to follow these healthy credit tips:
1. Use your current card responsibly and pay bills on time
2. Avoid exceeding your credit limit and reduce what you owe across all credit accounts
3. Apply only for the credit you need
4. Monitor your credit report and credit score
Where to find your credit card's APR
Since APRs can change, you’ll want to have a way of checking your credit card’s APR.
Log onto your credit card's website and download your most recent credit card statement. This statement should let you know your current APR and allow you to understand how it is being applied to your balance.
How to calculate your credit card's interest charges
There are different methods to calculate interest. For example, credit card issuers may use the daily balance method. Under this method, your outstanding balance at the end of each day is multiplied times the daily periodic rate (DPR), which is your APR divided by 360 or 365, depending on the card issuer.
Your credit card's billing statement should reflect these daily charges, but you can also calculate them yourself. Simply look at what you owe each day of a billing cycle and multiply that amount by the DPR - for each day a balance remains, add another interest charge to generate your total cost of interest for that billing cycle.
Alternatively, issuers can use the average daily balance method that totals the balance for each day of the billing cycle and divides that sum by the total number of days in the billing cycle. If the daily periodic rate (DPR) is used, this number is then multiplied by the DPR and the number of days in the billing cycle.
For either of these methods, interest may compound daily. It is important to check the terms and conditions of your credit card to know what method applies and how interest is calculated.
How to avoid paying interest on a credit card
As you might be able to see interest charges can add up over time. Responsible credit card usage means avoiding excessive interest so that your APR does not affect you too drastically. At the very least, always make your credit card's monthly minimum payments on time. To avoid interest charges altogether, savvy credit users will repay their entire credit balance each month on or before the due date.
If the option is available, you can use your credit card's online account to set up automatic payments. That way, you can choose to automatically pay off either your minimum payment or balance each month on or before the due date.
Credit Card APR: The Bottom Line
APRs are one of the most vital elements to understand when using credit cards. This rate can have a substantial influence how much you pay for your credit balance.
Examining the terms and conditions of your credit card's APR will help prepare you for the interest charges you may need to pay.
Disclosure: This article is for educational purposes. It is not intended to provide legal, investment, or financial advice and is not a substitute for professional advice. It does not indicate the availability of any Citi product or service. For advice about your specific circumstances, you should consult a qualified professional.