Credit Card APR: How Do Interest Charges Apply to Your Balances?
If you have credit card debt to pay off, high interest rates are probably the reason you can’t pay it off quickly. Credit cards are notorious for creating a “treadmill” of debt, where you pay and pay, month after month, but you never seem to get anywhere. The reason is often rooted in high APR that’s applied to your balances. These high interest rates eat away at every payment you make, which prevents you from reaching zero efficiently.
This guide helps you understand how credit card interest rates work and what you can do to get ahead of your debt. If you still have questions or would like to talk to a certified credit counselor about options that can help you minimize interest, call (844) 276-1544.
What is APR?
APR is an acronym that stands for annual percentage rate. This is the rate that the creditor applies to calculate interest charges if you carry a balance on your account. Interest charges are how credit card companies generate revenue whenever they extend a line of credit to a consumer. On credit cards, APR is directly equal to the annual interest rate charged on your balance. For loans, APR also may include some fees.
How credit card APR works
Interest charges only apply to credit card debt if you carry a balance over from month to month. If you start a billing cycle at zero, then pay off any charges in-full within that cycle, interest does not apply. This is how you can use high APR credit cards interest-free.
However, if you begin a billing cycle with an outstanding balance, then the creditor applies interest charges to the debt. Here is how that works:
First, the creditor calculates a periodic interest rate. This is the annual percentage rate divided into the number “periods” (billing cycles) within one year. In most cases, you can calculate the periodic interest rate on your account by dividing the APR listed in your bill by 12.
Then, the creditor multiplies your average daily balance by the periodic interest rate to calculate accrued interest charges for the month. This product is then added to your total credit card balance.
When you make a payment, the creditor deducts these accrued charges from the amount you pay. As a result, only a portion of each payment you make goes to pay off principal; that’s the actual debt that you owe.
High APR leads to higher accrued interest charges. So, if you have high credit card interest rates, it makes it difficult to get out of debt. With minimum payments, you may only pay off a few dollars at a time, depending on the APR.
Warning: credit card interest compounds daily
Credit card interest charges accrue quickly and that’s because of how fast it compounds. Compound interest means that interest charges from one cycle get rolled into the balance used to calculate the next cycle. Since credit card interest compounds daily, your balance grows a small amount with each day that passes.
This is why it’s so important not to let credit card debt linger. It’s growing with each passing day!
Types of credit card APR
A credit card may have multiple interest rates that apply at different times. The primary rate is known as purchase APR or standard APR for purchases. This is the rate applied when you use your card in a store, at a restaurant, or to shop online or through an app. However, that may not be the only APR listed in your credit card statement.
Promotional/introductory APR
This is a special rate that applies for a period of time after you open the account. In most cases, it offers 0% APR for 6-24 months, depending on your credit score. Once the promotional period ends, the standard purchase APR takes effect.
Balance transfer APR
This is the rate applied to balances you transfer to the card from other accounts. Balance transfers offer one type of debt consolidation, because they allow you to combine multiple balances on a single card. These cards typically offer promotional periods, such as 0% APR or low APR on transfers for 6, 12 or 18 months. Once the promotion period ends however, this rate tends to be higher than the standard rate for purchases
Cash advance APR
This rate applies only when you use your credit card at an ATM to withdraw cash. You can use a credit card to take out cash just like a debit card, but interest charges apply. Cash advance APR applies immediately; there is no grace period so interest charges begin to accrue quickly. This rate tends to be much higher than most other rates on the card. Most experts usually advise against using credit cards for cash advances, because this rate is so high
Penalty APR
This is the rate that the creditor imposes if you miss a payment by more than 60 days. Instead of applying the regular purchase APR, they apply a penalty rate. The average penalty APR rate is 29.99% You must make six consecutive payments on-time to remove penalty APR and restore your standard rate.
How do credit card companies determine my rate?
There is not one set rate, even for a specific credit card. The rate on your Capital One® Venture® card may be significantly different than your neighbor’s rate on the same card. That’s because creditors use a combination of factors to determine your individual rate. How high or low your credit card APR goes is largely based on the following:
- The benchmark interest rate from the Federal Reserve at the time you open the account. The current benchmark rate is between 0% and 0.25%.[1]
- Your credit score
- They type of card you wish to open. For example, reward credit cards usually have higher APR
If you have excellent credit and apply for a low APR credit card when the Fed drops interest rates, you can minimize interest charges. Changes in circumstances may change your rates.
IMPORTANT NOTE: Credit card APR can change!
Most (not all) credit cards have variable interest rates. That means APR can change based on what’s happening with the economy. If the Federal Reserve increases benchmark interest rates, expect your rates to increase, too. So, if the Fed raises the rate by 0.25% then you could see your credit card APR increase as well.
Of course, if the economy is weak and the Fed drops interest rates, it’s good for anyone carrying a balance. Your debt may be slightly easier to pay off. However, most credit card companies won’t lower your rates as quickly as they increased them after a Fed rate hike.[2]
You should watch the rates listed in your monthly statements to see if they reduce. If not, call the creditor to request that they lower your card’s APR.
