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Credit cards, APR and interest rates: Everything you need to know

Understanding how annual percentage rates work could save you a lot of money.

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When you borrow money, whether using a credit card or some other form of financing, you usually have to pay interest to the lender. In the case of credit cards, the rate you pay on your balance is known as your annual percentage rate (APR). 

You may have seen this term on your monthly credit card bill -- but not fully understood what it means. In contrast to an interest rate, an APR incorporates the interest and the fees you pay to borrow money. There are several different types of APR, and the amount of APR you pay can depend both on your creditworthiness and when you pay off your credit card balance.

Keep reading to learn what exactly an APR is, how it works and how to minimize your interest payments.

What is an annual percentage rate?

Annual percentage rate (APR) is the rate that you pay to borrow money. For credit cards, your APR is the price you pay to carry a balance on your credit card. APR is expressed as a percentage and represents the amount of interest and other fees you pay on the card over the course of an entire year.

Types of APRs

There are different types of APRs -- depending on the type of transaction. Here's an overview:

  • Introductory APR: Many credit cards come with introductory APRs that are lower than the card's normal APR. An introductory APR may be as low as 0%, but only for a limited amount of time.
  • Purchase APR: This APR applies to purchases you make on your credit card throughout the month and don't pay off by the payment due date.
  • Balance transfer APR: A balance transfer is when you move the balance of one credit card to another, often to take advantage of a low introductory rate. When the introductory rate ends, your balance transfer is subject to its own APR that is often higher than the purchase APR.
  • Cash advance APR: A cash advance is when you borrow money from your credit card balance in the form of a loan. Credit card cash advances often have a higher APR than purchases.
  • Penalty APR: If you violate any terms of your credit card, such as by missing a payment due date, you may be subject to a penalty APR that is higher than your purchase APR.

APR vs. interest rates: What's the difference?

Many people use the terms APR and interest rate interchangeably, but your APR and interest rate are two different things. The APR often represents the interest rate combined with other financing fees.

But in the case of credit cards. APR and interest rate really are the same. Whether a credit card advertises its rate as an interest rate or an APR, they are the same thing. Any other fees, such as annual fees and balance transfer fees, are charged separately from the APR.

Fixed vs. variable APR: What's the difference?

As with any other type of financing, credit cards can come with either fixed or variable APRs.

A fixed-rate credit card has the same APR the entire time you hold the card. This type of APR can be beneficial, especially when interest rates are low, as they allow you to lock in a low rate for the life of the credit card. You aren't vulnerable to rate hikes as the economy changes.

A credit card issuer can still change the APR on a fixed-rate card, but it's more difficult to do. They have to meet certain requirements, including providing sufficient notice to cardholders.

A variable-rate credit card is one with an APR that's tied to a particular index -- often the prime rate. As the prime rate fluctuates, so does the APR that credit card issuers are willing to offer their customers.

While it is possible to find a fixed-rate credit card, most credit cards have a variable rate. If you'd prefer a fixed-rate credit card, you'll probably have to look somewhere other than with the major credit card issuers. Instead, look to credit unions and local banks, which are more likely to offer fixed-rate cards.

How an annual percentage rate works

An APR usually applies to purchases and balances that you don't pay off. At the end of each statement period, your credit card issues a monthly bill. After your bill is issued, you have a grace period — usually about 21 days — during which your purchases don't accrue interest. 

Any purchases on your card that you don't pay off by the due date and the end of the grace period will begin to accrue interest. To calculate interest, banks use a daily periodic rate, which is your APR divided by 365. For example, with an APR of 20%, your daily periodic rate is .05479%.

To calculate the amount of interest you'll actually pay, divide your daily periodic rate by the number of days in a billing period, and then multiply that rate by the amount of your credit card balance that's subject to interest.

Here's how APR can cost you

Credit card rates are some of the highest of any type of financing. It's easy to get caught in the trap of racking up credit card debt, not paying your purchases off by the due date, and then seeing most of your monthly payments go toward interest moving forward.

According to Experian, the average credit card balance in 2020 was $5,315. If you had a credit card APR of 16% and only made the minimum payments, you could pay more than $6,500 in interest over the life of the card. That's more than the amount you actually borrowed.

"Credit card interest can greatly impact a consumer's ability to repay what was borrowed, if they are not careful," said Shanté Nicole, a credit coach and the founder of Financial Common Cents. "It's imperative to remain in control of your spending, ensuring that you have the funds to repay what was borrowed the moment the bill is due, and not depending on the minimum payments to keep you afloat. Each month the balance is carried beyond the due date, interest is charged, which can result in much deeper debt than the borrower intended."

The faster you pay off your balance, the less money there is to accrue interest, and therefore the less interest you'll pay over the life of the debt. Ideally, you'll pay your balance in full to avoid interest altogether, but if you can't pay more than the minimum to reduce interest charges.

"Credit cards should only be used for things you already have the money for," Nicole said. "This way, you're guaranteed to never pay interest. Once you borrow money for a purchase, pay in full on the due date. No balance is carried over and no extra fees are being paid."

What's a good APR?

According to CreditCards.com, the average rate on a credit card in the first week of August 2021 was 16.22%. You can use this number as a benchmark to help you determine if you're being charged a reasonable rate.

Remember that while the average rate might be 16.22%, that doesn't mean it's the rate everyone will qualify for. In general, the APR you're eligible for on a credit card or any other type of financing depends on your credit score. 

In general, the best APRs are reserved for those with high credit scores. For borrowers with lower scores, the average rate is significantly higher at 25.80%. One of the best ways to reduce the amount you spend on interest -- aside from paying your full balance each month, is to improve your credit score.