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What is APR and how does it affect credit card debt?

APR is a good indicator of whether or not you’re getting a good deal.

Jacob Palmer

Contributing Writer at Tally

December 4, 2018

Of all the numbers you’ll hear about when signing up for a new credit card, one is much more important to understand than the rest: annual percentage rate (APR).

APR determines whether or not you’re getting a good deal on a credit card. The higher the APR, the harder it is to pay off your card balance, if you fall behind on payments.  

But APR isn’t just an interest rate. There’s more that goes into it, and if you want to know exactly how it’s calculated, you need to read the fine print.

What’s APR?

APR is the interest you pay on a credit card account, plus the fees charged by your credit card issuer.

Some of these fees include insurance for your account. Other fees are costs the credit card company is passing on to the consumer, such as those attached to individual transactions and administrative costs.

APR includes more than just the basic interest rate, so beware of cards or loans that only advertise the interest rate. That interest rate may only be one aspect of what you’ll have to pay.

The most important thing to know about APR is that you’ll only be charged interest if you carry a balance from one billing cycle to the next. Paying off your balance every month may not be realistic, but it’s important to remember.

Are there different types?

Yes, APRs can vary based on how you use your credit card. You should look into the different rates when choosing a credit card.

  • Purchase: This is the rate applied to your credit card purchases.

  • Introductory: This is typically a lower rate that’s offered for a limited time. Also called a

    promotional rate, it can apply to specific transactions, balance transfers and cash advances.

  • Penalty: This is typically a higher rate applied to certain balances when you violate the terms and conditions of your credit card, like failing to make a payment on time.

Consider your specific needs when deciding on a credit card. Make sure to thoroughly review all of the APR details, as well as the terms and conditions of the card.

Want to make sure your actual interest rate is the same as the advertised APR? Time to break out the calculator.

How is APR calculated?

Knowing how your APR is calculated is useful, even if you plan to pay off your entire balance every billing cycle. It can offer insight into whether you’re getting a good deal or if your APR is more punitive than what your credit card company is advertising.

So, how can you check your rate?

Look at your statement or credit card account and find the listed APR. Remember: The actual number that affects your account may be different than what’s listed.

Though it’s called an “annual” percentage rate, you need to know how the APR breaks down on a day-to-day basis to see how it’s enforced. This number is known as a daily periodic rate (DPR).

To calculate your DPR, divide the APR by 365 — the number of days in a year.

Next, you need your average daily balance (ADB). This is because your APR is dependent on how much of a balance you carry from day to day.

To calculate your ADB, add up a month’s worth of transactions — one day at a time — and then divide the total by the number of days in that month.

Lastly, multiply your DPR and ADB. Multiply that product by the number of days (D) in that month.

Here’s how it looks as a mathematical equation:

DPR x ADB x D = Actual interest rate

So how exactly does this help?

You can affect your average daily balance by making payments throughout the month. If you intend to carry a balance over from one billing cycle to the next, it’s better to make a few smaller payments during that period than to make a bigger payment once at the end.

What if my actual interest rate is higher than my advertised APR?

You can minimize your actual interest rate by making multiple payments during one billing cycle.

On the other hand, you can make the situation worse by allowing interest to compound.

If you’re paying more in actual interest rate than the advertised APR, you’re likely allowing the interest to compound.

Some credit card companies compound interest daily; others do it monthly. If you’re carrying a balance over from one billing cycle to the next, interest is being added to your balance.

Keep in mind: Many credit card companies apply different rates to different types of transactions. Balance transfers, for example, may carry a different penalty than purchases at a store.

How can I avoid overspending on interest?

The best thing you can do is never carry a balance over from one month to the next.

If that isn’t possible, consider taking advantage of a promotional APR, if you can do it without incurring extra fees from balance transfers. Moving your balance over to an account with a promotional rate makes it easier to pay it off your balance without going further into debt.

The most important thing to know about APR is that you’ll only be charged interest if you carry a balance from one billing cycle to the next.

Another way to avoid overspending on interest is to scrutinize the advertised APR carefully before applying for a credit card.

If you know carrying a balance over from month to month is inevitable, try to find the lowest APR available. Also keep in mind that rewards credit cards typically carry the highest rates — it might seem like a great deal in giveaways, but rewards cards can be a dangerous proposition.

In general, a credit card that carries approximately 10% APR is considered a low-interest card. Reward cards regularly go for 18% and up.

Your credit will affect how high of an APR a credit card issuer will offer you, so it’s important to take care of your credit reports because it could pay off in the future.

Bottom line: Interest is only enforced on balances that are carried over from one billing cycle to the next. When carrying a balance is unavoidable, the best thing to do is to keep your average daily balance as low as possible. You can do that by making smaller, frequent payments on your balance throughout the billing period. Before signing up for a credit card, make sure you’re comfortable with the APR and understand you need to pay the entire balance every month to avoid overspending on your purchases.