What is APR on a credit card?
As a credit card holder, you’ve probably come across the term APR — or “annual percentage rate” — many times in the past. However, even if you have a rough idea of what APR means from your credit card statement or new credit card offers, it’s normal to still have questions about it.
The guide below helps demystify credit card APRs and how they work. Read on to find out what the term “APR” means, how credit card companies calculate interest on your account, and how you can avoid paying interest on your credit card.
What is APR on a credit card?
APR is short for annual percentage rate. It represents the annual cost you pay to borrow money from a lender or credit card issuer.
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For installment loans, such as personal loans or car loans, the APR includes interest and fees that the lender may charge. However, the APR you pay does not include annual fees when it comes to credit cards. In the case of credit cards, APR refers only to the interest rate.
What is a good APR?
The answer is somewhat subjective. According to Federal Reserve, the average interest rate on credit cards in August 2022 was 18.43% (interest accounts). So if you can find an APR that is below average, you can consider it a good one.
This TPG’s guide to the best credit cards is a great place to start your research on current low APR credit card options.
How credit card companies calculate APR
Before you understand how credit card companies calculate APR, it’s important to familiarize yourself with a few additional terms:
Daily interest rate
One of the most common ways to calculate your credit card APR is for the card issuer to divide your annual percentage rate by 365. This number is called your daily rate or daily interest rate.
Compound interest
Depending on the terms of your credit card agreement, the card issuer may take your daily rate and multiply it by your current balance or your average daily balance. The result is added to your total balance, increasing the amount you owe. This process is called daily compounding.
Average daily balance
To calculate your average daily balance, write down your credit card balance at the end of each day in your billing cycle. Then average those numbers together. (In other words, add the numbers, then divide the total by the number of days in the billing cycle.)
Depending on your credit card agreement, you may be able to use the following formula (perhaps with some modifications) to calculate the credit card interest you’ll pay per billing cycle:
Daily interest rate x average daily balance x number of days in the billing cycle = credit card interest.
Here’s an example that illustrates how a credit card APR works:
- Calculate the daily interest: Let’s say your APR is 18.25%. Your daily rate would be 0.05% in this scenario (18.25% ÷ 365 days = 0.05%).
- Determine your average daily balance: We’ll assume your average daily balance is $1,000.
- Look up the number of days in your billing cycle: We’ll assume a 30-day billing cycle for this example. This number may vary from one card issuer to another.
- Calculate: Using the hypothetical numbers above, a daily interest rate of 0.05% (0.0005) multiplied by an average daily balance of $1,000 multiplied by a 30-day billing cycle equals $15 in interest expense.
How to avoid paying interest on credit cards
It’s always nice to lock in the lowest possible APR when borrowing money. But with credit cards, your APR may not be as relevant as it is with other types of loans—as long as you follow a basic rule of thumb.
Here it is: You should aim to pay your statement in full by the due date of each billing cycle. This rule is also one of The Points Guy’s rules The 10 Commandments of Rewards Credit Cards.
When your credit card issuer sends you a copy of your credit card statement, you will have a grace period between the statement closing date and the due date on your account. According to the Credit Card Accountability and Disclosure Act of 2009, this grace period must last at least 21 days. As long as you pay off your balance during this grace periodthat is, by the due date, you should be able to avoid paying interest on your credit card account.
You can also opt to pay off your credit card early – before the closing date on your account statement. This strategy can help you reduce your credit card utilization rate on your credit report and maybe even improve yours credit score as a result.
However, if you are not in the habit of paying off your credit card balance every month, your credit card APR is very important. In this scenario, you should pay special attention to your credit card’s APR. Credit card interest fees have the potential to add up quickly due to the notoriously high interest rates compared to other types of financing and interest.
Conclusion
Credit cards can have many attractive benefits, especially attractive ones rewards credit cards which can give you the potential to earn points, miles, cash back and more.
However, it is important to understand how interest works on these accounts and the steps you should take to avoid such charges. Otherwise, high interest rates can offset the benefits you might get from credit cards.
Make sure you have a solid strategy track your credit card spending and hopefully avoid interest in the first place. And if you struggle with any credit card debtmake a plan to pay it off as quickly as possible to avoid wasting money on interest.
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