What Is an Annual Percentage Rate (APR)?

Paying off your balance helps avoid costly interest charges

Young woman in striped top looks at her phone with a credit card in hand on outdoor bench.
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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.

Whenever you borrow money, any interest you pay increases the cost of the things you buy with that money. Credit cards are a form of borrowing, and knowing a card’s APR helps you compare offers and understand the cost of paying with plastic. Plus, the APR helps when you’re comparing card or loan offers and making other financial decisions.

What Is an APR?

The annual percentage rate (APR) of a loan is the total amount of interest you pay each year represented as a percentage of the loan balance. 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.

If your credit card has a grace period (most cards do), you can avoid paying interest on your credit card balance by paying off your balance every month. Check with your card issuer to find out how to take advantage of the grace period.

APR vs. Interest Rate

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 additional charges in your APR. But credit card fees like annual fees and late payment penalties do not affect your APR.

Nominal vs. Effective APR

Although APR is supposed to help you understand your borrowing costs, 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? Whenever you pay additional fees, a more accurate representation of your borrowing costs would be an effective APR, which accounts for fees that increase your card balance.

Fixed vs. Variable APR

When an APR is fixed, the rate does not change over time. Most credit cards have a variable rate, but some store-brand cards feature fixed rates. With a variable rate, your rate can rise and fall 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, but you generally must receive notice at least 45 days in advance.

When interest rates rise, borrowing money becomes more expensive.

How Does a Credit Card APR Work?

One of the most important things to know is that you don’t necessarily have to pay interest. Most cards feature a grace period, which allows you to borrow money and pay no interest as long as you pay off your entire card balance each month. However, if you carry a balance on your card, you pay interest based on the APR.

Applying APR to Your Card Balance

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—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. 

For example, let’s say 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 (20% divided by 365 equals 0.0548%). Then, multiply that daily rate by your account balance ($6,000) for an interest charge of $3.29.

Multiple Types of APR

Your credit card may include several different APRs, so it’s important to use the right number as you calculate your expenses. For example, you might have an APR for purchases you make with your card, a different APR for cash advances, and another APR for balance transfers. More on that below.

Rules to Help You Understand Your APR

Lenders are required to display your APR (or multiple APRs, if applicable) 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.

Your cardholder agreement describes how lenders can change your rate, and credit card companies must follow the terms and conditions in your agreement. 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, and 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).

If you have a variable rate, the rate will automatically rise and fall following movements in an index like the prime rate. Likewise, if you have a temporary promotional interest rate, the rate will change when your promotional period ends.

Compare the rates you’re paying to average credit card rates to find out if you’re getting a good deal.

How Is Your APR Calculated?

Your APR often depends on interest rates in the broader economy. Your card issuer 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%.

For example, let’s assume that the prime rate is 3.25%, and your 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).

Lenders also set your interest rate based on your creditworthiness. Based on their willingness to lend to borrowers with your profile, they may price your card or loan according to their appetite for risk. That’s just one more reason to keep your credit scores as high as possible.

Multiple Types of Credit Card APRs

Your credit card may have multiple APRs, meaning you pay different rates depending on how you use your card.

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 promotional rate you might get as a new customer These rates may start low, but they have an expiration date, and your rate eventually rises.
 
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 a ATM (or other cash-like transactions) Rates tend to be relatively high, and you may also pay a separate cash advance fee. 

 

Penalty 

 
A rate increase resulting from 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 (above your minimum) to the balance with the highest rate. It’s always smart to pay more than the minimum, and that’s especially true if you’re paying high rates.

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

  • The annual percentage rate (APR) is the interest charged on your balance for the year.
  • APR illustrates how much you might expect to pay in interest over one year, although interest charges often accrue daily.
  • A variable APR can change when interest rates rise and fall.
  • Your card may have multiple APRs that apply to different categories of debt.
  • It costs money to borrow with a credit card if you can’t pay your balance in full when it’s due, and it’s critical to understand exactly how much you pay.

Article Sources

  1. Federal Trade Commission. "Credit, Debit, and Charge Cards." Accessed Sept. 24, 2020.

  2. Consumer Financial Protection Bureau. "The Consumer Credit Card Market." Accessed Sept. 24, 2020. Page 59.

  3. Consumer Financial Protection Bureau. "How Does My Credit Card Company Calculate the Amount of Interest I Owe?" Accessed Sept. 24, 2020.

  4. Consumer Financial Protection Bureau. "What Is a 'Daily Periodic Rate' on a Credit Card?" Accessed Sept. 24, 2020.

  5. Federal Reserve System. "Consumer Compliance Outlook." Accessed Sept. 24, 2020.