What does APR mean on a credit card?

As a cardholder, you may have encountered the term 'annual percentage rate' (APR). Even if you understand the basics, you might have questions about its personal implications—especially regarding your finances linked to credit card accounts.

This guide aims to clarify credit card APRs and their functions. First, we’ll explain what APR is; then, we’ll discuss how lenders compute interest on your balance and tips on how to avoid interest charges to keep more money in your wallet.

What is the meaning of APR on a credit card?

APR signifies the annual cost of borrowing from a lender or credit card provider.

For installment loans, such as personal or auto loans, the APR encompasses both interest and any fees that lenders may apply. However, with credit cards, the APR does not factor in annual fees; it solely represents the yearly interest rate.

What types of APR exist?

The most prevalent type of credit card APR is known as:

• Purchase APR: The interest rate charged on purchases made with your card. This rate can either be fixed or variable, meaning it can remain constant over time (fixed) or fluctuate based on the prime rate, which banks use to determine overall interest rates.

You might encounter a few other types of APR as well:

• Introductory APR: This is a special promotional interest rate offered for a limited time on a new card, sometimes dropping as low as 0%. It may apply to purchases, balance transfers, or both. Once the introductory period ends, the card will revert to its standard APR.
• Cash advance APR: This rate applies when borrowing cash from your credit card and is typically higher than the purchase APR, with no grace period. It's often used for convenience checks as well.
• Penalty APR: The penalty APR kicks in after missed or returned payments, potentially reaching as high as 29.99%. You may need to make several consecutive on-time payments before the penalty APR is lifted. It's best to avoid this situation altogether.

What constitutes a good APR?

So, what is considered a good APR? According to the Federal Reserve, the average credit card APR surpassed 20% in early 2024. By this standard, credit card APRs are notably higher than other types of consumer credit, such as some personal and auto loans. Therefore, a "good" credit APR might be one below 20%, although securing such rates can be challenging.

Credit card interest rates are typically quite high, with some exceeding 30%. Be sure to check the current rates for any cards you consider adding to your collection. At TPG, we always recommend paying off your cards each month to avoid interest charges, but we understand that this isn't always feasible.

How to determine APR on a credit card

To grasp how credit card companies compute credit card interest, it’s essential to understand a few additional terms:

Daily interest rate

Credit card issuers find the daily interest rate by dividing your APR by 365. This value is often referred to as your daily rate.

Compound interest

Depending on the terms outlined in your credit card agreement, the card issuer may take your daily rate and multiply it by either your current balance or your average daily balance. This result is then added to your total balance, increasing your debt. This method is known as daily compounding interest.

Average daily balance

To determine your average daily balance, record your credit card balance at the end of each day during your billing cycle. Then, compute the average of those figures by adding them together and dividing the total by the number of days in the billing cycle.

Depending on the specifics of your credit card agreement, you might be able to use the following formula (possibly with some adjustments) to calculate the interest charged on your credit card during a billing cycle:

• Daily interest rate x average daily balance x number of days in billing cycle = credit card interest

Here's an example to demonstrate how credit card APR functions:

1. Calculate daily interest: Imagine your credit card APR is 18.25%. In this case, your daily rate would be 0.05% (18.25% ÷ 365 days = 0.05%).
2. Determine your average daily balance: We'll assume your average daily balance is $1,000.
3. Identify the number of days in your billing cycle: For this example, let's say there are 30 days in the billing cycle. This can vary by card issuer.
4. Calculate: Using the hypothetical figures above, a daily interest rate of 0.05% (0.0005) multiplied by an average daily balance of $1,000 over a 30-day billing cycle results in $15 in interest charges.

How to avoid interest charges on credit cards

Securing the lowest possible interest rate when borrowing money is always beneficial. However, APR may not be as critical with credit cards compared to other forms of credit—provided you adhere to a crucial rule: always strive to pay off your entire statement balance by the due date of each billing cycle.

This guideline is also one of Dinogo's 10 commandments for maximizing credit card rewards.

When your credit card issuer provides you with a copy of your statement, there will be a grace period that falls between your statement closing date and the due date on your account.

According to the Credit Card Accountability Responsibility and Disclosure Act of 2009, this grace period must be a minimum of 21 days. As long as you settle your balance within this grace period, meaning by the due date, you can avoid incurring interest charges on your credit card account.

You can also choose to pay off your credit card balance ahead of time—before the statement closing date on your account. This tactic might help reduce your credit card utilization on your credit report and potentially enhance your credit score as a result.

However, if you typically don’t pay off your credit card balance each month, the credit card APR becomes crucial. In this case, you should carefully monitor your credit card's APR. Given their high average APRs, credit card interest can accumulate rapidly.

Bottom line

Credit cards offer a variety of appealing benefits, especially rewards credit cards that enable you to accumulate points, miles, cash back, and more.

However, it’s vital to grasp how credit card APR functions and the actions necessary to avoid unnecessary expenses. If not, high-interest charges can diminish any advantages you might gain.

Ensure you have a robust plan for monitoring your credit card expenditures and aim to avoid paying interest altogether. If you’re facing challenges with your credit card debt, devise a strategy to reduce it swiftly to prevent wasting money on interest.

For additional details, take a look at our compilation of the best 0% APR cards, which is an excellent starting point for your research on available low-APR credit card options.