APR vs. Interest rate: is there a difference?
You look at your credit card statement and sigh at the amount you owe this month. You desperately want to control your growing credit card debt, but every month the balance grows exponentially. Recent data from Experian shows that the average credit card balance in 2021 is $ 5,525.
Looking at the fine print, you see abbreviations and associated numbers, but don’t necessarily understand what that means for your bottom line. The words Annual Percentage Rate (APR) appear everywhere on your credit card statement as well as several mentions of interest rates. What do APR and interest rate mean? And does understanding these terms make a difference in the way you manage your finances? The short answer is yes.
Check out this guide on the ins and outs of APR and interest rates, and how to reduce both.
Is there a difference between the APR and the interest rate?
There is no difference between the APR and credit card interest rates. The APR is the annual rate for borrowing money, while the interest rate refers to the daily charges applied to the balance on the basis of the APR.
“Because interest accumulates overnight on a credit card, the terms APR and interest rate are often used interchangeably,” said Jim Pendergast, senior vice president of The Southern Bank Company in Alabama. .
How do credit card APRs work?
A daily credit card APR. “This means you pay interest on your unpaid balance every day you maintain a balance,” said Adem Selita, CEO and co-founder of The Debt Relief Company.
The APR depends on the timeliness of payment and an individual’s credit rating. Consumers need to be proactive in learning how the APR is calculated.
“Most credit cards charge variable rates, which means they can fluctuate based on an index such as the prime rate,” said Ted Rossman, senior industry analyst for Bankrate.com and Creditcards.com . The prime rate – what banks typically charge their customers – is currently 3.25%.
The APR is usually calculated by adding the prime rate plus the card issuer’s profit margin of, say, 15 percent. Rossman explains that in this example, the APR would be 18.25 percent.
Why are credit card APRs changing?
The easiest way for an issuer to raise rates is to link them to an underlying index like the prime rate, so if that index goes up, the card company can pass the increase on. Most credit cards have therefore tied their rates to the prime rate.
“When the Federal Reserve adjusts the federal funds rate, the prime rate moves in tandem. So it’s fair to say that the Federal Reserve plays a key role in setting credit card rates. However, card issuers still have some freedom, ”Rossman said. “As long as they give enough notice, they can increase rates on new purchases by setting up a larger margin. They cannot increase your rate on existing debt unless you are more than 60 days late with a payment.
How does credit card interest work?
Credit card interest is only relevant if you have month-to-month credit card debt. “The interest rate is the daily accumulation of interest derived from the APR,” Pendergast said.
Pendergast explains how the interest rate is calculated. Divide your APR by 365, multiply that number by your daily balance, and multiply that number by the number of days in the month.
So if your APR is 15%, your daily periodic rate will be $ 0.00041. If your current balance is $ 1,000, your daily interest rate will be $ 0.41. At the end of the month, your interest charge of $ 12.33 will be added to the balance of $ 1,000. In your monthly statement, the credit card issuer adds up all of the daily interest.
What is an APR voucher for a credit card?
APRs vary and depend on an individual’s credit score. “The best APRs are usually between 10% and 15%,” Pendergast said. He urges consumers to look for a credit card that offers 0% APR for the first few months in order to cultivate the habit of paying off balances on time.
For people with a great credit score, “the average to high single digits are really low for a credit card APR,” Rossman said. The Navy Federal Credit Union Platinum Card, for example, charges rates as low as 5.99%. The PenFed Gold Visa card advertises an APR as low as 7.49%. Both of these credit cards require exceptional credit scores.
Rossman noted that the current average credit card APR is around 16%. “If you have less credit, you can easily pay 20% or 25% on a credit card,” he said. “Some store credit cards charge around 30%. “
Lower your APR
If you have a high APR, there are ways to lower your rate.
The fastest option? “Start with the longest credit card you’ve had and talk to your financial institution,” Pendergast said. “Often times, banks and credit unions are ready to move when it comes to APR if you’re used to paying your balances on time. Most people fail to lower their APRs just because they don’t ask for it.
Rossman also encourages consumers to lower their credit card APR by paying off the balance in full. Since APRs are tied to credit scores, it’s also a good idea to review your current credit reports for accuracy.
An alternative is to find credit cards that offer 0% APR on new purchases, balance transfers, or both. The caveat is to make sure that you will be able to pay off your debt before the term expires.
How to avoid paying interest on your credit card
Here are some tips to avoid paying interest on your credit cards:
1. Pay your balance in full
Paying your account in full is the best way to avoid additional interest. If you have a monthly balance, you pay interest on that amount as well as any new purchases you make. Paying your monthly bill in full allows you to avoid the cumulative effects of credit card interest.
2. Sign up for a card with a 0% introductory APR
Here are some of the best deals currently available:
Citi Custom Cash Card℠
With the Citi Custom Cash Card, pay no interest on purchases or balance transfers for 15 months (13.99% to 23.99% variable ARP thereafter). This credit card rewards you for the purchases you make the most with an impressive 5% back on your highest spending category (up to $ 500 per bill cycle, then 1%). Plus, new card owners can earn 20,000 Thank You Points, worth $ 200 in cash back, after spending $ 750 in the first three months.
Wells Fargo Platinum Card
Wells Fargo Platinum has one of the longest introductory offers at 0%, with 18 months for purchases and balance transfers (16.49% to 24.49% variable APR thereafter). Other notable benefits include no annual fees and up to $ 600 in cell phone protection (after paying a $ 25 deductible).
Discover it® Cash Back
The Discover it Cash Back credit card offers a 14-month 0% introductory period for purchases and balance transfers (variable APR from 11.99 to 22.99 percent). This card also offers another introductory benefit called Cashback Match which will automatically match any cash back rewards you’ve earned at the end of your first year.
3. Use your grace period
If you pay your bill in full each month, your issuer is required to give you a grace period. This means that you have a minimum of 21 days between the end of your billing and the due date of a full payment during which you will not be charged any interest. By scheduling a larger purchase for the start of your billing cycle, you can effectively enjoy almost two interest-free months while you pay it off.
“While many credit cards offer this, be sure to call your credit card company and check to see if your credit card has a grace period and that you qualify,” advised Brian Walsh, planner. approved financier. You’ll usually lose your grace period once you start carrying a balance, and it may take several months of full payments each month to get it back.
4. Consider a balance transfer
If you’ve already accumulated a balance and have fallen behind on your payments, you may want to consider a balance transfer to take a break from interest while you work to pay it off. Balance transfers allow you to move a balance from a high interest rate credit card to a new credit card with a 0% APR introductory period that can last from 12 to 20 months, depending on the card .
Notable caveats about balance transfers include fees and restrictions. You cannot transfer a balance between cards from the same issuer and balance transfers will cost you between 3 and 5% of the transferred balance, often with a minimum of $ 5 or $ 10.
The bottom line
APRs and interest rates are determined by your credit history, timeliness of payments, and other factors. To eliminate concerns about incurring interest on your credit card, a best practice is to pay off your monthly balance consistently. When this isn’t a viable plan, consider options to lower your APR and explore strategies to avoid paying interest.
Navy Federal Credit Union Platinum Card and PenFed Gold Visa Card information was collected independently by Bankrate.com. Card details have not been reviewed or approved by the card issuer.