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When it comes to credit cards, there are a few key terms that are helpful to remember. Annual percentage rate (APR) is one of the most common — and important — phrases you’re likely to encounter because it determines the cost of borrowing on your card.
Here’s a look at what you need to know about APR.
Put simply, APR is the cost of borrowing on a credit card. It refers to the yearly interest rate you’ll pay if you carry a balance, and it often varies from card to card. For example, you may have one card with an APR of 9.99% and another with an APR of 14.99%. Credit card companies take your credit score into account when setting your APR, with a higher credit score generally translating to a lower interest rate.
Credit cards often have a variable APR, meaning your rate can go up or down over time. Variable APRs are tied to an underlying index, such as the federal prime rate, which is the lowest rate of interest at which banks will lend money. If the prime rate increases, your card’s APR would also increase, and vice versa if the prime rate goes down.
Interest charges are applied to your monthly statement, but because some months are longer than others, many credit card issuers use a Daily Periodic Rate (DPR) to determine the amount of interest you owe. This rate is simply the APR divided by 365 or 360, depending upon your card issuer.
The resulting DPR — expressed as a percentage — is multiplied by the number of days in your billing cycle. That amount is then multiplied by your average daily balance. The final total represents the interest charges for the month.
Here’s an example: Assume you’re carrying a $5,000 average daily balance at 15.99%. Your Daily Period Rate is 0.0438% (15.99% divided by 365) and there are 30 days in the billing cycle. Following the formula, DPR (0.0438) multiplied by the number of days in the billing cycle (30) multiplied by the average daily balance ($5,000), the monthly interest charge calculation would look like this: (0.0438%) x (30) x ($5,000) = $65.70 of interest charges for the month.
Credit card users should be aware that credit cards often have a number of APRs. For example, you may have one APR for purchases, a different APR for balance transfers, and another for cash advances. As a general rule, credit card companies tend to charge a higher APR for cash advances because — unlike purchases — there’s no grace period, meaning the interest begins accruing as soon as you withdraw the money.
It’s also important to know the difference between introductory and regular APRs. Many credit card issuers offer introductory or promotional rates when you open a new credit card account. (For instance, there may be a 0% introductory rate on purchases and balance transfers for the first 12 months.) Once the introductory period ends, the regular APR would apply to any outstanding balance on the card.
Finally, there’s one last APR to consider: penalty APR, which is a higher rate that’s imposed when you default on your card by missing two or more monthly payments. Depending on the card issuer, you may have to make a certain number of on-time payments before the penalty APR can be reduced to a lower rate. (Setting up automatic payments or payment alert reminders can help ensure your payments are made on time.)
As with any financial agreement, you’ll want to familiarize yourself with your credit card’s terms and conditions, including its APRs. Remember that APR is only applied if you are carrying an outstanding balance on your card, so you can typically avoid paying any interest charges if you pay off the balance of your card before the statement period ends each month.
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