What is APR?
What is a good APR?
How does interest work on a credit card
How to avoid interest on your credit card
How to lower interest on your credit card
What about 0% APR cards?
When it comes to considering credit card offers, it’s easy to get sidetracked by the merry-go-round of rewards and sign-up bonuses, but for many of us who don’t always pay our credit card in full every month, the best deal is getting the lowest APR on a credit card.
Here’s what to know about credit card APRs.
What is APR?
The Annual Percentage Rate (APR) is the yearly interest rate you will pay if you carry a balance month to month on a credit card. That’s key because of the 4 in 5 Americans who have a credit card, only half pay off their balances in full each month and avoid interest charges, according to a report by the Federal Reserve.
“An APR is like miles per hour,” credit pro Jason Steele told Yahoo Finance. “That's a standard rate of measurement even if you are driving for just ten minutes. Likewise, when we talk about interest, even though we might only carry a balance for a month or two, that rate of interest stated as an APR is as if we were accruing interest for an entire year.”
Lenders can set APRs on newly issued cards as they see fit, usually depending on your creditworthiness, so there’s a wide range of APRs to consider when you’re shopping for a new credit card. There are several different APRs per card to consider, too.
There’s an APR for the interest rate you pay on purchases called your purchase APR. There’s another APR if you tap your credit card to get a cash advance or write a check using your credit card account. There’s a balance transfer APR as well as a penalty APR if you make a late payment.
These APRs are spelled out in your credit card’s terms and conditions. Your card statement also will show each category with a different APR and the amount of your balance that falls in each category.
While you can find credit cards that offer fixed rates, most credit cards have variable rates and go hand in glove with the Federal Reserve prime rate hikes or drops. Any rate change by the Federal Reserve typically filters down to the APR.
Moreover, a card issuer can revise your credit card terms for future purchases, but they’re required by law to notify you 45 days in advance of any significant changes such as a bump up in your APR.
What is a good APR?
Hello. The best APR is going to be 0% if you plan to carry a balance. That said, these deals are typically for a set timeframe and are offered to new cardholders, or if you’re transferring a balance from another card.
The average credit card APR in early August was 15.13%, according to the Federal Reserve, while the APR for cards that carried a balance—meaning they weren’t paid in full by the payment due date—averaged about 16.65%.
The best low-interest rate credit cards currently offer variable APRs that start at around 13.49%, but you will need a good credit score to land one.
In reality, what’s a good APR for a credit card depends on a myriad of factors. The biggest factor that determines what you’re likely to land, though, is hands down your credit score.
“There’s a strong correlation between the interest rates you'll pay and your credit score or what they would call an inverse correlation,” Steele said. “The higher your credit score, the lower your interest rate. The better you can do at increasing your credit score, the better interest rate you'll receive from your card issuer. Scores anywhere from 670 to 850 are the sweet spot.”
Issuers also typically judge your creditworthiness on your income — not your assets — to make sure you will have the ability to repay your loan. That can trip up self-employed workers with an uneven income stream who may be considered riskier than those with an employer W-2 and regular paychecks.
If you carry a balance and have a top-notch credit score, the best APR deal is generally a no-frills card that has an APR below 10%, but offers no rewards. These are usually not advertised and are issued by credit unions, Steele said.
“If you're shopping for a mainstream credit card with rewards, you're probably looking at those low double digits. If you have a credit score of 740 or above, that’s probably going to come in around 12% or 13%,” he said.
Keep in mind a late payment or two can trigger an APR hike that could make your APR as high as 29.99% on some cards.
How does interest work on a credit card?
Credit card companies, by law, give you at least 21 days, often called the grace period, from when they send you your bill to when they require payment on the due date. If you don’t pay in full, you pay interest, period. The only way to avoid paying interest on your credit card balance is to pay it off in full each month.
“Once you start carrying even a penny over to the next month, you start accruing interest,” Detweiler said. “And keep in mind the grace period usually applies only to the category of new purchases and only if you were not already carrying a balance.”
Most issuers use the accounting method called average daily balance to calculate how much interest you’re charged. That means interest is charged on the average balance each day rather than the actual balance you owe at the end of the billing period, Detweiler said. By calculating the interest you owe daily, the interest amount is then added to the previous day’s balance.
There is variance. Some issuers use the average daily balance method with compounding. Others use the average daily balance method without compounding. The fine print in your cardholder agreement will disclose the method used.
“The most important thing for a cardholder to understand is that if you aren't paying your balance in full and benefitting from the grace period, you'll be charged interest on the average daily balance, not just the amount you didn't pay off that month,” she said. “That could mean more interest charges than you expect.”
To figure out how much interest you would be charged, take your daily periodic interest rate times your average daily balance times the days in your billing cycle. You can typically figure the daily periodic interest rate you will be charged by dividing the APR by 365.
“It's a little bit different than an ending balance because you could have some days where the balance is higher and some days where the balance is lower and those average out to give you your interest charge for the month,” Detweiler said.
The truth is few of us are actually going to run those daily computations. It’s a head-spinning whirl of decimal points.
“It's really beyond the ability of the average person to break out a calculator and do it because they'd have to make dozens of calculations each month,” Steele said. “Ultimately, you have to trust the credit card industry and their computers to make that calculation and compound that interest daily.”
What's changed more recently is that “some cards allow you to pay certain purchases over time and pay interest on those purchases, but still use the rest of your credit limit more like a debit card where you can pay off in full and avoid interest,” Detweiler said. “It allows you to make your credit card more flexible by allowing you to choose which purchases you'll pay interest on, and then avoid interest on the rest by paying those off in full each month.”
How interest adds up
Let’s say you carry a credit card balance of $5,000, with an APR of 15.1%. If you make the minimum monthly payment of 4% of your balance, it would take 123 months — or more than ten years — to pay it off. Total payments would be $7,207.15. Total interest charges: $2,207.15.
But if you paid off that $5,000 in charges in full before interest started to accrue, you would pay only that $5,000 in spending. Total interest charges: $0.
How to avoid interest on your credit card
It seems easy: Pay your card in full each month by or on the due date.
“The whole concept of having your interest charges waived when you pay in full is really powerful,” Steele said. “Let's say you have a $1,000 balance and you pay $999. So you're thinking, oh, I only owe interest on a dollar. No, no, no. The interest has been accruing on your average daily balance the whole time. And it only gets waived if you pay the entire statement balance in full by the due date. So even though you pay the $999, you will still have an interest rate on virtually that entire $1,000 for that entire time.”
With credit cards, grace periods typically apply only to purchase transactions. If you use your card to get a cash advance or use a check you received from your card issuer, generally you must start paying interest as of the date of the transaction.
One way to make sure you don’t get caught in the revolving interest trap is to automate monthly bill payment. Schedule an automatic transfer for the balance due from your checking to your credit card issuer on or before the due date.
“You could also save money on interest by making your payments earlier,” Steele said. “There's no rule against you making multiple payments. Most people see that due date and they think, well, I'll just pay it by the due date, and I'll be good. And you will, but if you pay it a day, or a week earlier, you're saving interest by reducing that average daily balance. There's no reason you couldn't make five, 10 payments a month.”
How to lower interest on your credit card
If you’re already swamped with a high-interest payment, apply for a balance-transfer card with a promotional 0% APR for a limited time–up to 21 months on some cards. It typically comes with a one-time 3% to 5% fee on the balance you are moving.
Check and see if your card is offering any new promotions. These pop up in your mailbox from time to time. If you haven’t seen one lately, it’s worth a call to the customer service line to see if there’s one you might have missed. New ones come online all the time.
For example, say, the standard variable rate on your card is a 17.49% APR, there might be a promotional APR rate on new purchases of 3.99% for six months, before the APR heads back up to the higher rate. The hitch is you must activate the promo rate by calling the issuer or tapping into the special purchase rate site.
Another way to reduce your interest on your existing card is to contact your creditors via the toll-free number on the back of your card and simply ask about getting a lower interest rate. If your credit score has improved since you were issued the card, that’s in your favor.
“I can’t underscore how important it is to bump up your credit score,” Susan Weinstock, CEO of the Consumer Federation of America, told Yahoo Finance. “It can take some time, but that's super important because it really is the heart of what they base your APR on.”
Asking does work, particularly if you have been a cardholder for several years and have made your monthly payments on time and in full in the past. Some creditors might also remove fees you may have racked up from making a few late payments, providing you agree to make your monthly payments going forward or if you’ve always made timely payments in the past.
In a nutshell
For the credit card with the best APR, you’ll need a credit score ranging from 670 to 850. Generous credit card deals offering hefty initial sign-up reward bonuses, no annual fees, cash back earnings and 0% APRs for nearly two years are tantalizing, if you pay your balance in full each month, but they generally come with a higher APR than a simple charge card without the whistles.
Kerry is a Senior Columnist and Senior Reporter at Yahoo Money. Follow her on Twitter @kerryhannon