How does the APR work?:key points

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Let’s say you have an average of $5,000 in debt on your card and your bank charges you an annual percentage rate of 12%. That’s $600 in annual interest.

Now imagine that instead of 12%, your credit card APR is 20%. In that case, your annual interest charge would become $1,000.

Therefore, here you will learn how the annual interest rate works, the difference between interest rate and APR, and how to choose a credit card to minimize your interest costs, among others.

Are the interest rate and APR the same thing on a credit card?

On credit cards, the APR and interest are the same things.

The annual interest rate you pay to your APR credit card issuer for having an outstanding balance on your card is usually expressed as an annual rate.

Therefore, it is called the “Purchase APR”. This is the interest rate you pay for the things you buy with your credit card.

Does having a card with a high APR mean you will have to pay high-interest costs? Not necessarily.

Paying your credit card balance in full every month does not incur any interest.

However, the purchase annual percentage rate is not the only one you should consider. There are other types of APRs you should be aware of.

APR rates on credit cards

These are the different types of interest rates or APR on a credit card:

Purchase APR

This is the APR you pay on the outstanding balance of purchases that you carry over to the next billing cycle.

Introductory Purchase APR

Banks use an introductory purchase APR to attract customers. These interest rates are lower than usual rates and may even go as low as 0%.

For example, the Chase Freedom Unlimited credit card has an introductory APR of 0% for 15 months.

In this case, you must carefully monitor the interest-free period. After it ends, the issuer’s standard APR applies, which ranges from 13.99% to 26.74%.

Balance Transfer APR

As its name suggests, this APR applies to the amount you transfer from another card. You should be careful about these balance transfer fees.

Cash Advance APR

If you need cash quickly and you don’t have money in your bank account, you can use your card’s cash advance service. You simply withdraw funds from an ATM. But be prepared to pay a high price for it.

The Chase Freedom Unlimited Credit Card charges a cash advance APR at a rate that is 21.74% higher than the Prime Rate. You can get to pay a maximum annual rate of 29.99%.

Penalty APR

If you make a late payment or your payment is returned by your bank, your credit card issuer may impose a “Penalty APR”.

This rate could be much higher than the purchase APR.

While most card issuers impose a penalty APR in certain circumstances, credit cards like the new Apple Card do not penalize customers with this additional interest.

Which is better, fixed or variable APR?

When studying the APR or the interest rate on a credit card, a card that offers a fixed percentage is a good option. As its name indicates, this interest rate does not change. However, there are a couple of points to remember.

Although the card issuer’s documents may refer to a “fixed” rate, it is possible that the rate will change at some point.

To change the rate, the bank would have to inform you about the proposed change, and you would have the option to cancel the card if you are not willing to accept the interest increase.

There is another way the APR can change even on a “fixed APR” card.

A penalty APR may kick in if you fall behind on your payments.

Also, keep this in mind: most card issuers prefer to provide variable APRs.

A study of 413 credit card issuers found that only 111 provide cards with fixed APRs.

A significant percentage of these issuers are community banks and credit unions.

If your card has a variable rate, how to calculate what you have to pay in interest? The applicable interest would be calculated by adding the prime rate to the margin charged by the bank:

Important message for small business owners: 

You can avoid the uncertainty of variable interest rates by opting for a business loan from Camino Financial instead of a credit card. Our rates are fixed for the life of the loan, and you will never face an increase in interest costs due to an increase in the market rate.

Camino Financial microloans and business loans have an interest rate that ranges from 12% to 40%.

By aamritri

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