What Is APR?

Annual Percentage Rate Explained

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An annual percentage rate (APR) is the interest rate you pay each year on a loan, credit card, or other line of credit. It’s represented as a percentage of the total balance you have to pay.

Learn more about how APR works, the different types you might have to pay, and how to save money.

Definition and Examples of APR

The annual percentage rate (APR) of a loan is the total amount of interest you pay each year. This is calculated before compounding interest is taken into account. APR represented as a percentage of the loan balance.

When you borrow money, any interest you pay raises the cost of the things you buy with that money. Credit cards are a form of borrowing, as are loans and lines of credit.

Knowing a card or loan’s APR helps you compare offers. It also shows you the true cost of what you are buying.

For example, if a credit card has an APR of 10%, you might pay roughly $100 annually per $1,000 borrowed. All other things being equal, the loan or credit card with the lowest APR is typically the least expensive.

How Does APR Work?

When you borrow money through a loan, credit card, or another line of credit, you have to pay interest on the money you borrow. The APR is the total rate you pay every year for that loan or credit balance.

With credit cards, the APR and the interest rate are often about the same. Other loans, such as mortgages that require you to pay closing costs, include those charges in your APR. But credit card fees like annual fees and late payment fees do not affect your APR.

When you keep a balance on your card, your card issuer uses the APR to calculate how much interest to add to your balance. Many card issuers charge interest using your daily balance. This is the amount of money you owe at the end of each day.

To do so, the credit card company divides your APR by 360 or 365 to convert to a daily periodic rate. 

Suppose your APR is 20%, and you have a daily balance of $6,000 on your card for the month. Your card issuer assumes 365 days per year. How much interest will you incur today?

To calculate this, find the daily periodic rate. Then, multiply that daily rate by your account balance:

20% / 365 = 0.0548% x $6,000 = $3.29

The interest you owe for that day is $3.29.

Lenders are required to display your APR (or multiple APRs) on your statement. As a result, you can always see how much debt you have at each rate. If you have questions about those rates, call your card issuer or loan servicer.

Your loan paperwork or cardholder agreement describes how lenders can change your rate. Credit card companies must follow the terms and conditions in your agreement.

With a loan like a mortgage, you will have to pay an APR. That's because you own interest on the loan every month until it is paid off. With a credit card, though, you don’t always have to pay interest.

Most cards feature a grace period. This allows you to borrow money and pay no interest as long as you pay off your entire card balance each month. If you carry a balance on your card, you pay interest based on the APR.

Nominal vs. Effective APR

An APR can help you understand the cost to borrow money or use a credit card. But it’s not perfect. The number you see quoted from a credit card issuer is a nominal APR. But what if you pay charges like cash-advance fees at an ATM?

When you pay additional fees, a more accurate representation of your borrowing costs would be an effective APR. This accounts for fees that raise your card balance.

Fixed vs. Variable APR

When an APR is fixed, the rate does not change over time.

A fixed-rate mortgage would have the same interest rate and APR for the life of the loan. Most credit cards, though, have a variable rate. (Some store-brand cards feature fixed rates.)

With a variable rate, your rate can rise and fall. This is most often in response to an index like The Wall Street Journal’s prime rate.

Even with a fixed rate, your card issuer can change the rate. If that happens, they need to notify you, often at least 45 days in advance.

When interest rates rise, borrowing money becomes more expensive. Compare the rates you’re paying to average credit card rates to find out whether you’re getting a good deal.

If you have a fixed interest rate, the Credit Card Accountability Responsibility and Disclosure (CARD) Act of 2009 requires lenders to notify you of a rate change at least 45 days in advance. That rate generally only applies to new purchases.

Federal law also regulates rate changes that lenders use to penalize you when you pay 60 days late (or more).

How Is Your APR Calculated?

Your APR often depends on interest rates in the broader economy. Your lender may add an amount (known as the "margin") to an index like the prime rate.

Add those two numbers together to calculate your rate. For example, lenders may say that you pay the prime rate plus 9%.

Suppose the prime rate is 3.25%, and your credit card’s APR is the prime rate plus 9%. Add 3.25% to 9% to arrive at your APR of 12.25%. If your card issuer assumes 365 days in each year for billing calculations, your daily periodic rate would be .034%, which is 0.1225 divided by 365.

Mortgage lenders often set your interest rate based on your creditworthiness. They may price your card or loan using both current interest rates and how much of a risk it is to lend you money.

Things like a higher income, lower debt, and a good credit score make you less of a risk. The lower the risk, the lower your APR.

Types of APR

A credit card or line of credit may have multiple APRs. This means that you pay different rates, depending on how you use your credit.

Type of Rate Description Important Details
Purchase The rate you pay for most purchases   If you use your card for spending online, at merchants, or for bill payments, this rate typically applies.
Introductory A rate you might get as a new customer These rates may start low, but they have an expiration date, and your rate will rise in time.  
Balance transfer The rate you pay on debt you move over to your credit card You might start with a low promotional rate and face a rate increase later. You could also pay a balance transfer fee.
Cash advance The rate you pay for getting cash from an ATM (or other cash-like transactions) Rates tend to be high, and you may also pay a second cash advance fee.   
Penalty    A rate increase due to late payments   Your rate rises, but you may be able to reduce the rate with a series of on-time payments.  

Whenever you pay more than the minimum required each month, card issuers generally must apply the excess to the balance with the highest rate. It’s always smart to pay more than the minimum. This is especially true if you’re paying high rates.

Suppose your card has a $5,000 balance with a purchase APR of 12% and a $2,000 balance with a cash advance APR of 21%. Your total card balance is $7,000. Y

our minimum payment is 2% of the total balance, or $140. But you pay $440 this month because you want to eliminate debt. The credit card company must put the extra $300 toward reducing your high-rate, $2,000 cash advance balance.

Key Takeaways

  • Borrowing money through a loan, credit card, or line of credit means you will have to pay interest.
  • The annual percentage rate (APR) is the interest charged on your balance for the year, which may be different than your daily or monthly interest rate.
  • A variable APR can change when interest rates rise and fall.
  • Your card may have multiple APRs that apply to different types of debt.