Credit Card Interest Rate vs. APR: What You Need to Know

By Matthew Frankel Markets Fool.com

Interest rate and APR have different definitions, but are used interchangeably when it comes to credit cards. Essentially, APR is the annualized cost of borrowing money, including interest charges as well as any borrowing fees. Many credit cards have variable APRs that change over time, and some have 0% APR introductory offers that can save cardholders money.

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What do interest rate and APR mean?

An interest rate is the price you pay for borrowing money, typically quoted on an annual basis, as a percentage of the amount you borrow. However, it's important to note that an interest rate doesn't account for other costs that may be associated with borrowing, such as a loan's origination fee.

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APR stands for annual percentage rate and tells you the actual costs to borrow money for one year, including interest and additional fees. If you get a mortgage, for example, and pay a $1,000 origination fee, this would be factored into your APR along with the interest rate.

Credit card APR

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In credit cards, the terms APR and interest rate are often used interchangeably, since there are typically no origination or other fees associated with borrowing money on a credit card. Credit card issuers generally express their rates as APR.

Some credit cards charge annual fees, but it's important to point out that these are not included in your APR, since they are charged whether or not you use the card for purchases. To be included in APR, a fee must be directly related to borrowing the money.

Credit card interest is typically compounded on a daily basis, and your APR is broken down into a daily rate. This is calculated by dividing your APR by 365 days (360 days in some cases). So, a 15% APR would correspond to a 0.041% daily interest rate.

This daily rate is then multiplied by the number of days in the statement billing cycle and by your average daily balance over that time period. Your average daily balance is obtained by adding your credit card's balance on each day of the statement period, and dividing by the number of days.

Most credit cards have variable APRs that are based on a certain index, such as the U.S. Prime Rate. If the underlying index rises, the APR on your credit card will likely rise as well. Additionally, many credit cards have different APRs for different types of transactions -- specifically, one for purchases and one for cash advances.

Finally, many credit cards have low-APR introductory offers. In fact, some cards offer a 0% APR for as long as the first 21 months of card membership. Here's a guide to some of our favorite 0% APR credit card offers right now.

Example of credit card APR

Let's say that you have a credit card that charges an APR of 18%, which translates to a daily rate of 0.0493%.

In one 30-day month, you charge a $1,000 purchase on the 16th day -- so your balance on days 1-15 is $0, and on days 16-30 is $1,000, for an average daily balance of $500. To compute your interest charge for the month, your credit card issuer will multiply your daily rate of 0.0493% by 30 days, and then by $500, for a total interest charge of $7.40.

Of course, this is a simplified example, and you can avoid interest charges by paying the balance off by the statement due date.

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