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.
Contributing Writer at Tally
November 4, 2022
Of all the numbers you’ll hear about when signing up for a new credit card, the most important to understand is annual percentage rate (APR).
APR measures the amount of interest, fees and penalties that you will pay on credit card debt. It determines whether or not you’re getting a good deal on a credit card. The higher the APR, the more it costs to carry debt on a credit card.
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.
This guide will explain APR credit card considerations that you need to know.
What is APR and how does it work?
APR stands for annual percentage rate. APR is the annual cost of a loan to a borrower. This includes the interest, plus any associated fees and penalties. This is the main difference between APR and interest rate; APR includes fees.
APR applies to credit cards, mortgages and other loan types.
What is APR on credit cards? It is the interest you pay on a credit card account, plus the fees charged by your credit card issuer.
For example, a credit card with an APR of 20% will charge 20% interest when you carry a balance. That means a $100 charge would accumulate around $20 in interest over a one-year period, if you didn’t make any payments towards it. (This is a simplified calculation that ignores the impact of minimum payments and compounding interest, but it’s still useful for conceptualizing APR).
APR includes more than just the basic interest rate, as it also includes fees and related penalties. Thanks to the Truth in Lending Act, lenders are required to disclose all borrowing costs to consumers.
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.
If you pay off your full balance every month, you won’t be charged any interest. So, APR doesn’t matter if you pay on time (and pay your full balance). But if you carry a balance, you will be charged interest based on the card's current APR.
It’s wise to understand that APR varies due to a number of factors.
Creditworthiness: If you have good credit, you’ll typically be offered a lower APR.
Card type: The type of credit card could influence the credit card APR.
Interest rate environment: The overall interest rate environment also influences the APR on lending products. If interest rates are rising in general, APRs will also rise.
Finally, credit card APRs are typically variable, which means they change over time.
If you sign up for a card and are offered an 18% APR, that rate may increase in the future.
What is a good APR?
A “good” APR is tough to determine, as there are many factors at play.
According to recent data, the average credit card APR is now over 21%. Rates that are lower than this could be considered “good,” but again, it varies.
Are there different types of APRs?
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.
Cash advance: This rate applies to cash advances (when you use a credit card to borrow cash). It’s typically higher than the purchase rate.
Introductory: This is typically a low rate that’s offered for a limited time. Also called a promotional rate, it can apply to specific transactions and balance transfers
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 cost of borrowing 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 APR?
First, look at your credit card statement or online account and find the listed APR. Then, consider how APR is actually calculated (or use an APR calculator).
Though it’s called an “annual” percentage rate, the APR is calculated on a day-to-day basis. 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. You can minimize your actual interest rate by making multiple payments during one billing cycle.
What if my actual interest rate is higher than my advertised APR?
If you’re paying more in actual interest rate than the advertised APR, you’re likely allowing the interest to compound. APR does not include the effects of compounding interest.
Compound interest is the interest cost that accumulates on prior interest. For example, if you have a $50 charge for interest, that $50 will be added to your balance — and will start to accrue interest on its own.
Most credit card companies compound interest daily. 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 rate than regular purchases.
How can I avoid overspending on interest?
There are several ways to minimize or avoid paying interest altogether:
Pay off your statement balance in full each month.
Take advantage of a promotional APR offer.
Consolidate credit card debt to a lower interest rate.
Shop around for the best rates.
Consider credit card alternatives, like personal loans or lines of credit.
Improve your credit score so that you may qualify for a better APR.
The best thing you can do is never carry a balance over from one month to the next. This way, you can take advantage of the perks of a credit card (like rewards) without paying a dime in interest.
If you know carrying a balance over from month to month is inevitable, try to find the lowest APR that you can qualify for. Also, keep in mind that rewards credit cards typically carry the highest interest rates — it might seem like a great deal at first, but carrying a balance on a rewards card can be costly.
Your creditworthiness will affect the APR a credit card issuer will offer you, so it’s important to make sure your credit reports are accurate because the information in those reports can affect how much you pay for credit.
APR stands for annual percentage rate, and it’s a measure of the total cost of borrowing (interest, fees and penalties) that you will pay if you carry a balance on your credit card. Remember, if you pay your card off in full each month, you won’t pay any interest!
If you have existing credit card debt, you might consider looking into Tally†. Tally helps qualifying applicants consolidate credit card balances into a lower-interest line of credit. Learn how Tally works.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. Based on your credit history, the APR (which is the same as your interest rate) will be between 7.90% - 29.99% per year. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.