The purchase APR on a credit card tells you how much more expensive the items that you charge to your card will become over the course of a year if you carry a balance from month to month. In other words, it’s the rate at which a balance from purchases will accrue interest on an annualized basis if you don’t pay your bill in full by the due date.
For example, if you buy something for $1,000 with a credit card that has a purchase APR of 10%, and you pay for $500 of it by the due date, the remaining $500 balance would grow to $550 in 12 months if you don’t pay it off before then. Credit card interest is actually assessed daily, though. That means your effective interest rate is the purchase APR divided by 365 (days in a year), and the interest you’re charged one day becomes part of the balance accruing interest the next. So the interest charges accrued in that example would actually be a bit more than $50 as a result.
Complicating matters a bit is the fact that a single credit card can have multiple purchase APRs. Most common is a card with a purchase intro APR in addition to a regular purchase APR. For example, 0% APR credit cards offer a 0% purchase intro APR for a certain number of months after account opening, which is followed by a regular purchase APR of 10%-20%+. Any balance remaining at the end of the 0% period will be subject to the regular APR. That’s how it works with general-purpose 0% cards on the Visa, Mastercard, American Express or Discover network, at least.
Retailers often offer promotional financing if you spend a certain amount or buy an item in a particular category. In some cases, these deals involve straightforward purchase APRs. But when retailers offer 0% interest on purchases, it generally includes a feature called deferred interest. This means interest will retroactively apply to your original purchase amount if you don’t bring your balance to zero by the end of the designated 0% period. A purchase APR advertised as 0% “if paid in full by” a certain date is a sign that deferred interest is in play.
All the different varieties of purchase APRs might have your head swirling a bit. So a few practical examples may come in handy.
Here are some examples of purchase APRs on credit cards:
- 0% Intro Purchase APR: Chase Freedom Unlimited® – 0% for 15 months
- Low Intro Purchase APR: First Hawaiian Bank Heritage Credit Card – 2.99% for 8 months
- Low Regular APR: Amalgamated Bank of Chicago Union Strong Mastercard® Credit Card – 9.25% (V)
- Average Regular Purchase APR: 19.02% (new offers)
- Average Length of 0% Purchase APR: 11.26 months (new offers)
Of course, purchase APRs aren’t the only kind of credit card interest rate you have to worry about. You’ve also got balance transfer APRs, both introductory and regular, as well as cash advance APRs and penalty APRs. Plus, most credit cards have variable rates, which change based on the economic climate, but there still are some cards with fixed interest rates. You can learn all about the different types of credit card rates below.
- Purchase APR: The rate by which unpaid purchase amounts grow over time.
- Balance Transfer APR: The rate by which debt transferred from a loan or line of credit to a credit card will increase in cost until fully repaid.
- Cash APR: The annual cost of carrying a balance from a cash advance, not including the cash advance fee. There is no grace period for cash advances, which means interest kicks in right away. Cash APRs tend to be very high – usually above 21%, according to WalletHub's Credit Card Landscape Reports. And cash advance fees tend to be around $8. Given the high cost, this type of transaction should be reserved for emergencies only.
- Default/Penalty APR: Credit card companies automatically apply a higher default/penalty APR when the accountholder makes certain mistakes, such as missing payments or exceeding their credit limit. The default APR can only affect existing balances if you fall at least 60 days behind on monthly minimum payments. Credit card companies are allowed to increase the interest rate for future transactions at any time after an account has been open for at least a year. But they are required to provide 45 days’ notice of the change and can only apply the higher rate to transactions made 14 days after the notification is sent.
While credit cards have a number of different interest rates, penalty fees and membership fees are not among them. A credit card’s interest rate and fee structures are entirely separate. However, fees and interest are mixed together when added to your principal balance.
There are a number of reasons why credit card interest rates can change. Some are related to how you manage your account. Others are out of your control. One of the most common scenarios is when an introductory, or promotional, APR ends and a regular APR takes effect. Credit cards with 0% APRs are a prime example. Those 0% rates, whether applicable to purchases or balance transfers, don’t last forever. They give way to a regular APR after a certain period of time.
Introductory Rate / APR: Often referred to as a “teaser rate,” an introductory APR is the low (sometimes 0%) rate that credit card companies advertise to entice new customers.
- Intro APRs typically apply to purchases, balance transfers or both. Cash APRs are not included in most cases.
- Introductory rates only remain in effect for a predetermined length of time (usually 6-18 months), known as the introductory term or period. When the introductory term concludes, higher regular rates kick in. As a result, a credit card with a low introductory APR is only worthwhile if you can pay off most, if not all, of your balance before regular rates take effect.
- If you are late paying your monthly bill, the credit card company might revoke your introductory APR ahead of schedule and move you to the Default APR (usually above 20%).
Regular APR: This is another way of referring to the interest rate(s) that apply to purchases, transfers, and cash advances after the introductory APR period is over. If you do not pay your monthly bill on time, the regular APR can switch to a higher default APR.
Credit card rates usually are tied to certain indices, which fluctuate based on changes in the economic climate. We will explain how such rates work in greater detail in the following section.
You may have heard the terms “fixed” and “variable” used to describe credit card interest rates, or seen the “(V)” noted next to a percentage in a card’s terms. So let’s clear up any confusion you might have about this. Simply put, a fixed rate will not change (at least as far as existing balances are concerned) unless you misuse your account or a promotional period ends. Variable rates, on the other hand, are loosely tied to Federal Reserve policy and fluctuate along with changes in the overall economic climate.
More specifically, variable credit card rates are usually based on something called the “Prime Rate.” The Prime Rate is the interest rate banks charge their most creditworthy customers, which are usually large corporations. It changes as a result of fluctuations in the Federal Funds Rate, which applies to the money banks lend one another. Sometimes, the LIBOR (London Interbank Offered Rate) will be used in place of the Prime Rate. The LIBOR is essentially the British version of the Prime Rate, and it’s often employed by internationally-based financial institutions.
That background is important to understanding the differences between fixed and variable APRs, which you can learn more about below.
- Fixed Rate / APR: Locks in your APR so it doesn’t fluctuate with changes to the “Prime Rate.” A fixed APR does NOT mean the interest rate on your credit card will never change, however. Misusing your account could result in a penalty APR taking effect. And credit card companies can always raise your rate for future transactions with proper warning.
- Variable Rate / APR: Changes over time, along with the Prime Rate. So if the Prime Rate goes up 1% next month, your credit card rate will also go up by 1%. If the Prime Rate goes down, then your credit card rate will go down as well – unless the credit card company has a minimum rate. For example, a credit card company might set your rate at “10%” or the “Prime Rate + 8%,” whichever is higher. That would mean your rate could not dip below 10% even if the Prime Rate drops to 1%.
These days, most credit cards have variable rates. It’s hard to find a credit card with a fixed rate for an extended period of time.
One of the most confusing things about interest rates is the fact that the same terms (e.g. APR) mean different things for different types of financial products.
For instance, when APR is used in the context of credit cards, it speaks to the theoretical rate by which a balance will grow over the course of a year and does not take fees into account. With mortgages, on the other hand, certain fees (but not all fees) are factored into the APR. APRs cannot be used for direct product comparison between loans of different lengths, either. Interest rates for shorter-term loans tend to be higher than those for longer-term loans since they won’t be assessed for as long.
So whenever you’re evaluating financial products, make sure to determine what’s included in the APR and what you’ll have to pay on top of that amount.
Part of the confusion surrounding interest rates stems from the fact that so many different terms are thrown around. It makes the topic seem far more complicated than it actually is. For example, you’ll hear the terms “rate,” “interest rate,” “APR,” “annual percentage rate,” and “finance charge” all used to describe the cost of carrying a credit card balance from month to month.
With the exception of “finance charge” (which includes both fees and interest), all of those terms pretty much mean the same exact thing. APR stands for annual percentage rate, and it’s essentially the amount by which your debt will rise in cost over the course of a year, to compensate the bank or credit union for lending you the money. In other words, interest is used to account for the difference in value between money that one has now (which could be saved in order to earn positive interest over time) and money obtained at a later date.
It is important to note, however, that credit card APRs are a bit different in theory and in practice. Credit card companies calculate interest on a daily basis, and it compounds over time, meaning the interest you incur in a given month gets added to your principal balance and that total amount accrues interest the next month. As a result, your Effective Annual Rate (EAR) will typically end up being at least 10% higher than the APR listed on marketing materials and application forms. That’s often referred to as a “nominal interest rate.”
For example, let’s say that your credit card has a 25% APR and you carry a $100 balance for a year. You’d think that amount would grow to $125 by year’s end. But it would actually rise to about $128.39, making your EAR 28.39%.
The differential between APR and EAR isn’t uniform either. The higher your APR is, the greater the disparity will be.
Credit card debt is extremely expensive, and we have way too much of it right now. So you should avoid carrying a balance from month to month with your credit card unless you have a 0% introductory purchase APR.
If you pay your balance in full every month when your card’s regular APR is in effect, you won’t be charged interest. In fact, you’ll have a grace period between when your monthly statement is generated and when your bill is due, during which time interest will accrue on the balance listed on the statement. But if you don’t pay in full by the due date, you lose your grace period. As a result, interest will begin to apply to your purchases the day you make them, until you pay in full two months in a row and get your grace period back.
That’s one reason why it’s helpful to use the Island Approach. Basically, that means using different credit cards for different types of transactions. You could, for example, use a rewards card for everyday spending and a 0% card for a big purchase that will take a while to pay off. That way, your everyday purchases won’t be charged interest, and you can get two cards that are each great in some way rather than one that’s average all-around.