The average American household with a credit card carries nearly $8,400 in credit card debt — and credit card debt is risky to carry for two reasons.
First, credit cards have compounding interest. This means that your interest charge is based on your total balance, including the principal and any interest accumulated to date.
Second, credit cards tend to have high annual percentage rates (APR). Once you start accumulating credit card debt, it’s challenging to pay it off.
But does APR matter if you pay on time? The short answer is no, as long as you pay in full. Still, you should understand what APR is, how it impacts your credit report and how to avoid falling into credit card debt.
APR is the interest rate on your credit card. With some lending options — such as a mortgage or car loan — the APR and interest rate are different. However, with credit cards, the APR and interest rate are the same.
APR determines your minimum payment amount and how long it will take to pay off a credit card balance. You may incur various fees when using a credit card, including those associated with:
- Late fees on past-due payments
- Cash advances
- Balance transfers
- Annual fees, typically seen on cash-back and rewards cards
These fees are added to your credit card balance. Also, different scenarios may trigger different APRs.
Many credit card companies have a different APR for various situations. Each APR is a predefined rate. While the rate itself won’t change, certain activities generate a specific APR.
Credit card issuers offer this APR for a limited time during an introductory period. It’s a lower APR than the purchase APR.
This is the APR that the issuer assigns to everyday purchases. When opening a credit card, focus on the purchase APR since this is the interest rate that impacts you the most.
Credit companies sometimes offer promotional APR. A promotional APR has an expiration date and may last a few weeks or months. There may be other thresholds, like minimum monthly purchase requirements. Introductory APR is also a type of promotional APR.
If you have a credit card with a high APR, you can transfer the balance to a card with a lower rate. However, a new APR — the balance transfer APR — kicks in when doing so.
A balance transfer APR usually doesn’t apply until after the first 12 months. As such, you have a one-year grace period to pay off the balance without being charged additional interest. Card issuers also include a balance transfer fee of 3%-5% of the total amount transferred, which is applied to your balance immediately.
Many credit card companies allow you to withdraw cash at an ATM (cash advance) with a cash advance APR. This rate is higher than the purchase APR. You may also be charged a withdrawal fee.
If you break the terms of your credit card agreement, there is a penalty APR. Things you can do to break your agreement include:
- Making late payments
- Not making minimum monthly payments
- Exceeding the credit limit
- Allowing unauthorized use of your card
The penalty APR is significantly higher than the purchase APR. The CARD Act of 2009 requires companies to give 45-days notice before charging this rate.
APR matters depending on whether you make payments by the due date and if you pay your credit card bill in full. If you pay in full every month, the APR doesn’t matter. However, if you do not pay in full every month, APR can make a significant difference.
If you pay in full every month, your interest rate becomes irrelevant. By paying in full, you don’t have an outstanding balance on which your issuer can charge interest.
Furthermore, by paying the balance in full, you keep a one-month grace period in place for future purchases. For instance, if you spend $650 in January and your statement is due February 25, interest won’t start accruing unless you miss the February 25 payment. You won’t accrue interest under the grace period until the transactions hit your statement and the due date passes.
A grace period isn’t required by law. Read the fine print of your credit card agreement before making purchases, so you know what happens once you start borrowing money.
If you don’t pay your balance in full, the issuer charges interest on the remaining balance. Using the example above, if you pay $250 toward your $650 balance on February 25, you have a $400 outstanding balance remaining. Credit card issuers apply your APR to the $400 balance immediately. They also charge interest on any new purchases the day you make them. There is no longer a grace period.
Issuers determine the interest you owe based on your average daily balance. Every day that you carry a balance impacts that amount of interest that your issuer charges. This is why the cost of borrowing via a credit card can be so high. If you don’t make payments in full, your interest compounds quickly, and it becomes more challenging to get out of debt.
Paying your credit card balance in full each billing cycle is ideal. It’s the most responsible thing you can do from a personal finance perspective because it boosts your credit score and keeps you out of debt.
Over time, paying your balance in full improves your credit history, which yields more favorable interest rates in the future. Lenders for credit cards, auto loans, mortgages, personal loans, and student loans reserve the lowest APRs for those with good credit.
If you currently have bad credit or aren’t in a position to pay in full each month, you can still improve your financial situation.
Your monthly credit card statement shows a total outstanding balance and minimum payment due. If you cannot pay off the entire balance, make the minimum payment at the very least. If you have room in your monthly budget to make more than the minimum payment, that’s even better.
Although you’ll still incur interest on the outstanding balance, you’ll avoid late fees. If you do not make minimum payments, your penalty APR kicks in, costing you more in the long run.
If you have funds available, pay down your balance early. Even if you cannot pay the balance in full, paying off some of it lowers your average daily balance. However, don’t do this at the expense of missing your next minimum payment. Pay what you can afford. Gradually chipping away at the balance decreases the interest that you accumulate.
If you’re struggling to manage your monthly payments, consider getting a line of credit with Tally.
Tally uses your credit line to strategically pay your credit cards in the optimal way to get you out of debt faster and save you money. Similar to a balance transfer, you can use your low-interest Tally line of credit to pay off your high-APR credit card debt.
Tally manages all your credit card payments and tracks your balance, due date and APR for every card. All you have to do is make one payment to Tally per month.
Credit cards can be a useful tool, but they can also be risky because of the high APRs they tend to carry.
But does APR matter if you pay on time? If you make timely payments in full, there’s no need to worry about your APR. But if you don’t pay your balance in full, your APR matters. Many credit cards have APRs between 20% and 30%, which means it could cost you much more in the end.
If you cannot make payments in full on time, there are other solutions to help. Making the minimum payments, paying off small amounts early, and using a service like Tally can help you manage credit cards and pay off debt faster.