What is an APR?

The term APR means “Annual Percentage Rate”. This is the amount you pay on a yearly basis for carrying a balance on a credit card.

This doesn’t mean that if you have a card with an 18% APR you pay 18% each month.

The APR is divided by 12 based on a calendar year, which means you are actually paying 1.5% per month in this example. This is sometimes called the cost of credit.

Example:

You have credit “card A” with a balance of $500 at an APR of 24%. At the end of the month, your balance will be assessed 2% (24% / 12=2% monthly). Your new balance will be $500 x 102% or $510.

Now here’s a twist:

Each recurring month, the new balance will be assessed the 2%, so it really compounds. If you didn’t pay on the balance last month, your new balance will be $510 x 102% or $520.20. This continues on and on, so it is a good idea to pay those balances down as soon as possible.

Types of APR’s

Differential APR - A differential APR means the rate charged for a cash advance will probably be higher than the one assessed on purchases. For instance, a credit card carrying a 15% APR on purchases may charge up to 20% on cash advances.

Relating this example to numbers, a cash advance of $300 would cost you a whopping $60 finance charges! That is almost as much interest as you would pay for a short term pay day loan.

Tiered APR - This means that the rate you pay will increase as your balance increases. Credit card companies do this to discourage clients form holding large account balances for extended periods of time. Credit “card A” may carry an APR of 15% on balances from $0 to $2000 while balances above $2000 will gather 17.9% and over $5000 pays 19.9%.

Penalty or “Default” APR - Some credit card companies sometimes will institute a “penalty APR” on habitual late payers. The card issuer can do this at anytime according to the terms of service, so if your rate is raised, it affects the entire current balance. So it pays to be punctual with your payments.

Introductory APR - Card companies will offer a ridiculously low APR to entice people to apply for a new card. These introductory offers are only valid for a pre-determined period of time, like 6 months or 12 months. After that time, it goes up to a usually much higher rate, or the default rate.