As a credit card holder, you’ve probably come across the term APR — or “annual percentage rate” — many times in the past. However, even if you have a rough idea of what the term APR means from your credit card statements or new credit card offers, it is normal that you still have questions about it.
The guide below helps demystify credit card APRs and how they work. Read on to find out what the term “APR” means, how credit card companies calculate interest charges on your account, and how you can avoid paying interest charges when it comes to your credit card. .
What is the APR on a credit card?
APR is an abbreviation of the term Annual Percentage Rate. It represents the annual cost you pay to borrow money from a lender or credit card issuer.
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With installment loans, like personal loans or auto loans, the APR includes both interest and fees that a lender may charge. However, the APR you pay does not include annual fees for credit cards. In the case of credit cards, APR represents only the interest rate.
What is a good APR?
The answer is somewhat subjective. According to Federal Reserve, the average credit card interest rate in August 2022 was 18.43% (accounts assessing interest). So if you are able to find a lower than average APR, you might consider it good.
This guide to the best TPG credit cards is a great place to start your research into today’s low APR credit card options.
How Credit Card Companies Calculate APR
Before understanding how credit card companies calculate APR, it is important to familiarize yourself with a few additional terms:
Daily interest rate
One of the most common ways to calculate the APR on a credit card is for the card issuer to divide your annual percentage rate by 365. This figure is called your daily rate or daily interest rate.
Depending on the terms of your credit card agreement, a card issuer may take your daily rate and multiply it by your current balance or your average daily balance. The result is added to your overall balance, increasing the amount you owe. This process is called daily compound interest.
Average daily balance
To calculate your average daily balance, note your credit card balance at the end of each day in your billing cycle. Then average these numbers together. (In other words, add the numbers then divide the sum by the number of days in the billing cycle.)
Depending on your credit card agreement, you may be able to use the following formula (possibly with some adjustments) to calculate the credit card interest you’ll pay during a billing cycle:
Daily interest rate x average daily balance x number of days in billing cycle = credit card interest.
Here is an example to illustrate how the APR of a credit card works:
- Calculate daily interest: Suppose your APR is 18.25%. Your daily rate would be 0.05% in this scenario (18.25% ÷ 365 days = 0.05%).
- Calculate your average daily balance: We’ll assume your average daily balance is $1,000.
- Check the number of days in your billing cycle: We’ll assume a 30-day billing cycle for this example. This number may vary from one card issuer to another.
- Calculate: Using the hypothetical numbers above, a daily interest rate of 0.05% (0.0005) times an average daily balance of $1,000 times a 30-day billing cycle equals $15 in fees of interest.
How to Avoid Paying Interest on Credit Cards
It’s always nice to lock in the lowest APR possible when borrowing money. But with credit cards, your APR may not be as relevant as with other types of credit – provided you can follow one key rule.
Here it is: you should strive to pay your full statement balance by the due date of each billing cycle. This rule also happens to be one of The Points Guy rules. 10 commandments of credit card rewards.
When your credit card issuer sends you a copy of your credit card statement, you have a grace period between the closing date of your statement and the due date on your account. According to the Credit Card Accountability and Disclosure Act 2009, this grace period must last at least 21 days. As long as you pay off your balance within this grace period, i.e. before the due date, you should be able to avoid incurring interest charges on your credit card account.
You can also choose to pay your credit card balance early, before the statement closing date on your account. This strategy could help you reduce the rate of credit card usage on your credit report and maybe even improve your credit score as a result.
However, if you are not used to paying off your credit card balance every month, your credit card APR is very important. In this scenario, you need to pay close attention to the APR of your credit card. Interest charges on credit cards can add up quickly due to notoriously high interest rates compared to other types of financing and compound interest.
At the end of the line
Credit cards can have many attractive benefits, especially appealing rewards credit cards that can give you the opportunity to earn points, miles, cash back and more.
Still, it’s important to understand how interest charges work on these accounts and what steps you can take to avoid these charges. Otherwise, high interest charges can offset any credit card perks you may receive.
Make sure you have a solid strategy in place to track your credit card spending and hopefully avoid interest charges in the first place. And if you’re struggling with credit card debt, create a plan to pay it off as quickly as possible to avoid wasting money on interest.