Understanding Credit Card APRs & Interest Rates

The interest rate you have to pay for borrowing money on your credit card is called Annual Percentage Rate (APR). Many people don’t understand how credit card APR works. It is common knowledge that the lower the APR, the better. This topic, however, is much more complicated than it seems on the surface. This guide will help you understand everything you need to know about credit card APR. 

  • Overview: There are various types of APRs. We’ll explain the different kinds of credit card APR, when they are applicable and what the usual interest rates are. 
  • Credit Card Bill and APR: APR has an impact on both your total credit card balance and how the payment is distributed to your bill.
  • How to Lower Your APR: If you’re trying to refinance your credit card debt or fix your past mistakes, this section explains your options. 
  • APR vs. Interest Rate: the Calculation: This section explains how the interest is calculated based on APR. 

Overview of Credit Card APR: Types

Although APR is a form of interest rate, the two are not the same. APR is an annualized term. Interest doesn’t need an entire year to be applicable. Usually, most credit cards compound interest daily. The interest rate that you actually pay is called an effective interest rate. The guidelines given below explain how you can convert APR into the effective interest rate. The section focuses on giving you an overall understanding of APR and when it’s applicable to you.

The terms and conditions section of your credit card specifies different APR rates. Based on how you take out credit, all of these rates may apply to you.

  • Purchase APR: This APR applies for all purchases made using your credit card. It is the most common of the different interest rates and the one you consider first while deciding on a credit card. 
  • Balance Transfer APR: This APR is charged when you transfer a balance to your new credit card. Sometimes the balance transfer APR can be higher than the purchase APR. 
  • Cash Advance APR: This rate of interest is charged when you make a withdrawal. This rate of interest is not quite as high as the Penalty APR but it tends to be meaningfully higher than purchase or balance transfer APR. The cash advance APR is dangerous since it doesn’t have a grace period which means the interest is applicable from the day you make the withdrawal. We talk more about grace periods in the section below. 
  • APR Grace Period: Banks allows credit card users a grace period- within this period, users can pay off their debts without getting charged the interest. Most banks calculate interest using the average daily balance method. If you can pay off your debt within the grace period, which tends to be around 25 days, you don’t have to pay interest on that bill. This is why it’s advisable to pay off your credit card bill regularly. 

How Does APR Affect Your Bill?

APR has a significant effect on your credit card bill. Interests are accumulated over time using APR and are applied to your balance when making payments. 

This is common knowledge that APR has a direct impact on how much you pay if you carry a balance. At the end of each billing month- a percentage of the outstanding balance is added to the total which is the fee the bank deducts for extending your credit. 

How Can You Lower Your Credit Card APR?

The sections above have explained the severe consequences of having a high APR. Fortunately, there are a number of ways to avoid high credit card APR. 

To consolidate your credit card debt you can move your due balance over to a 0% intro APR balance transfer credit card. These cards are designed to help you pay your excessive debts. Some balance transfer credit cards offer 15-21 months of 0% APR beginning from the time of purchase. But you must not use these credit cards to buy anything! Because these credit cards tend to have a very high purchase APR which is paid at the very end. When you buy something and make a payment using a 0% APR card, it will be applied to the transferred balance. Until you pay off the transferred balance, you will have to pay interest on new purchases using the card. 

If your APR gets increased due to missed payments, you can get it lowered by paying off the minimum bill for several bill cycles & improving your credit score. It is not likely for your APR to go back to the way it was- but you still have a chance to get it lowered. 

How to Calculate Credit Card Interest

Unfortunately, credit card companies don’t explain the APR in a helpful manner. For example, the knowledge that the interest of your credit card is 25% (i.e. the average APR of credit cards in Singapore) doesn’t help you understand how much interest you’ll be paying on your next month’s bill if your balance is S$5,000. In the following section, we will explain how credit card interest is determined using an example. Following this guideline, you will be able to calculate the actual interest from your APR. 

Use the different variations of this formula to calculate the exact interest for the month: 

Total Credit Card Interest for a Month = Balance x Daily Periodic Rate x Number of Days in a Billing Cycle

You might be thinking, where does the APR come into this formula? The APR is in play, it’s just hidden. The formula uses a term Daily Periodic Rate or DPR which is basically your APR divided by the number of days in a year. This rate is used instead of APR since the interest is accumulated daily and APR is an annual rate. Replacing the DPR by APR/365, we can rewrite the formula as: 

Total Interest = Balance x (APR / 365) x Number of Days in a Billing Cycle

The number of days in a billing cycle is simply the number of days between two consecutive bills. Hence this number changes with the month. 

“Balance” is a confusing term and requires elaboration. It is used as a placeholder for different terms. It can indicate “adjusted balance” or “average daily balance”. We mentioned the most common ways of calculating this balance while different institutions use different formulas. Average daily balance is calculated by adding the balance at the end of each day and dividing that number by the number of days in that billing cycle. It means, even if you purchase one thing using the card at the beginning of the month, that balance will accumulate throughout the month while calculating the interest. Using the average daily balance, we can rewrite the formula as:

Total Interest = Sum of Daily Balances X (APR / 365)

Once we combined the two formulas, the number of days in a billing cycle canceled out. This formula is simple, however, if your balance has several APRs, this formula becomes complicated. In that case, the total interest is calculated by adding the interests for each APR and balance. The formula can be written as:  ∑ Balance_n x (APR_n / 365), where n represents the APR and its corresponding balance. 

Let’s revisit the example given earlier. Say your balance is S$5,000 and your APR is 25%. To make it easier to understand let’s assume that the S$5,000 charge was made on the last day of your billing cycle. In that case, you will pay: (S$5,000) x (0.25/365) = $3.42 in interest.

Why is Paying APR Bad for You?

From the above example, it might seem that the APR is negligible. You only had to pay a S$3.4 fee for an expenditure of S$5,000 which is only 0.068% of the total amount. What you have to understand is that the example assumes the expenditure was made on the last day of the billing cycle which means you paid off the debt the day after the purchase was made.Instead of making that $5,000 purchase at the end of the billing cycle, you make it at the beginning. The sum of daily balances equals $125,000 (assuming a 25 day billing cycle). In this case, the interest you have to pay becomes S$125,000 x (0.25/365) = S$85.61! It changes from the negligible amount of 0.041% to 1.7%.

By paying interest, you are paying more for items than they are worth. Let’s continue with our example from above. If you bought a S$5,000 TV, you probably did so because you deemed it to be worth S$5,000. However, if it takes you a long time to pay that item off, and by the time you are done, you have paid S$200 in interest, that purchase ended up costing you a total of S$5,200. It’s an often overlooked concept. It is important that we understand the true cost of the items and services we purchase – otherwise, we might end up making a decision we otherwise would not have, given all the information.

This is why we always urge our readers to pay off their credit card balances in full – before interest is charged. Small purchases like socks, meals, and movie tickets are rarely worth more than what you are paying for them. Therefore, paying interest on top of that price is a bad deal

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