Understanding Annual Percentage Rate (APR)
Topics: credit cards, apr, annual percentage rate, interest, interest rate, finance, personal finance
When calculating the true cost of your credit card, the most important factor to consider is the Annual Percentage Rate (APR). This is the amount of interest added to your card’s balance expressed as a yearly rate. To determine your monthly interest rate, the APR is divided into a periodic rate, usually daily.
To determine the daily interest rate, you simply need to divide the annual rate by 365. For example:
13.49% / 365 = .0369589%
The interest rate of a credit card can be either variable or fixed. A variable rate is linked to an economic indicator such as the prime rate and fluctuates as this indicator fluctuates. A fixed rate does not fluctuate with the economy, but rather is determined by the credit card issuer. However, don’t let the name mislead you. The rate is not necessarily fixed. The card issuer can increase the rate at any time as long as they give you advance notice.
If you miss a payment or are late with a payment, you interest rate can also increase. The credit card companies often use this as a reason to increase your rate to very high levels.
Methods of Computing Balances
There are several different methods for calculating your credit card balance. Whichever method your company uses must be clearly stated on your statement and in your cardholder agreement. Most major credit card companies use one of the following three methods:
1. Average Daily Balance. With this method, the issuer simply averages your daily balance by adding up the balance from each day and then dividing that number by the number of days in the billing period. Credits to your account from the month are deducted, but purchases are usually not included. This is the most common method used.
2. Adjusted Balance. This is the most consumer-friendly method used. The issuer takes the oustanding balance from the beginning of the billing cycle and deducts any payments or credits. For example, if you beginning balance was $1,500 and you made a payment of $500, interest would only be charged on the remaining $1,000. Purchases are always excluded when using this method.
3. Two-cycle Balance. This method works similarly to the Average Daily Balance method but is uses the prior two billing cycles rather than just the most recent. This is the least advantageous calculation method for card holders.
Peter Kenny is a writer for Finance 123. Please visit us at www.finance-123.com and www.shopsmartloans.com
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