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Basic facts about credit card APRs

An Annual Percentage Rate (APR) is the yearly rate of interest on your credit card. But why do APRs sometimes vary from the first year to the next and from transaction to transaction? What do they have to do with your bill? Here are some useful facts about APRs and how they affect your credit card account.

Different types of transactions, different Annual Percentage Rates (APRs)

A single credit card account can have several different APRs. For example, your credit card issuer may charge one APR for purchases and another for balance transfers. Also, some APRs can vary over time. Issuers may encourage you to use your card by offering promotional APRs that give you a lower interest rate on certain types of transactions for a set period of time. When the promotional period is over, the APR may adjust to a higher level, raising the cost of carrying a monthly balance. Used wisely, however, these low promotional rates can save you money.

All of the APR information is clearly displayed in a comparison box or chart in your credit card Agreement and on the issuer's credit card site. Be sure to check it thoroughly.

Variable vs. Non-Variable APRs

A variable APR is calculated by adding a set number determined by the credit card issuer (called the margin) to a reference rate (called the index) such as the U.S. Prime Rate. When the Prime Rate goes up or down, your variable APR may change, depending on whether your issuer updates your rates monthly or quarterly. Review your account agreement to find out how often this might happen.

A non-variable APR is not determined by a reference rate, so it's more stable than a variable APR. However, a non-variable APR is not always guaranteed. Most issuers reserve the right to change even a non-variable APR based on things such as how you use and maintain your credit accounts and on market conditions—but they’re required to notify you first. Be sure to review your account agreement for details.

How your monthly interest charge is calculated

Interest charges are calculated on a monthly basis. Since months vary in length, most credit card issuers use a Daily Periodic Rate (DPR) to calculate interest charges. The DPR is calculated by dividing the APR by 365. That number is then multiplied by the average daily account balance (more on that in a moment) and by the number of days in the statement billing cycle. Here's the basic formula used to calculate your monthly interest rate:

Balance x DPR x days in statement billing cycle = interest for that month’s statement

How your account balance fits in

Because your balance may vary from day to day, credit card issuers use different methods to determine the balance that is subject to interest charges. The 2 most common methods are the average daily balance and the adjusted balance:

  • An average daily balance is calculated by adding up each month's daily balance and dividing that number by the number of days in the month. This is the method most commonly used by issuers.
  • An adjusted balance is calculated by subtracting the previous month's balance from the total and then basing the interest charges on the remaining balance

Don't worry about memorizing this information. Just look for the portion of your credit card statement that indicates the method of computing the balance for purchases.

How payments are applied to your balance

Remember that different rates can be applied to different types of transactions made with the same card. This means that transferring a balance from another card may be more or less expensive over time than purchases made with the same card, when considering the overall cost of carrying a balance.

Perhaps your APR for balance transfers is zero, and your APR for new purchases is 15%. When you make a payment against the outstanding balance, your credit card issuer will apply any amount you pay above your total minimum payment toward your balance with the higher rate (in this case, your new purchases).

However, if you pay only the total minimum payment, your credit card issuer may apply it to the balance with the lowest rate first. This should motivate you to pay more than the minimum payment, since the higher rate portion of any outstanding balance will grow faster over time.

Make sure to carefully review the minimum payment allocation information in your account agreement to fully understand how your payments are applied to your account.

Remember: If you make a late payment or miss a payment entirely, you may be subject to a Penalty APR.

Understanding APRs can help you better understand how interest is charged, how your credit card payments are applied and how you can save on monthly interest fees and charges—and that's great news for your financial health.