Annual percentage rate (APR) is the estimated yearly cost of borrowing money, expressed as a percentage of the total amount borrowed. The APR includes the interest charges that will apply to a balance, as well as related fees in some cases.
Key Things to Know About APRs
- Many different types of financial products have APRs, including credit cards, auto loans, mortgages and personal loans.
- Annual percentage rates serve as a basis for choosing between similar financial products (e.g. between multiple credit card offers or mortgages).
- You should be able to find any financial product’s APR listed on the original borrower agreement as well as the periodic statements that you receive.
Some credit cards even offer an introductory APR of 0%. You can check them out using the link below, and then continue reading to learn more about APRs and how they work.
How Credit Card APR Works
The APR on a credit card dictates the interest that you will pay when carrying a balance from month to month. You will not incur interest on purchases if you pay your bill in full every month.
When you do carry a balance, credit card interest is assessed on a daily basis. There are three major steps to this interest calculation.
How to Calculate Credit Card Interest Based on the APR
- The issuer calculates the average daily balance on the card, which is just the balance the card had every day of the month added up, divided by the number of days in the month.
- The daily periodic rate gets calculated. The daily periodic rate is the card’s APR divided by 365 (the number of days in the year).
- The average daily balance gets multiplied by the daily periodic rate. That determines one day’s interest. Then, multiplying by the number of days in the billing cycle determines the interest for the whole period.
Now that you know the basics of how credit card interest is calculated, let’s take a look at how to do the math, along with an example.
Formulas for Credit Card Interest Calculation
Average Daily Balance = total daily balances / number of days in the billing cycle
Daily Periodic Rate = APR / 365
Interest Charges = average daily balance * daily periodic rate * number of days in the billing cycle
Note: “total daily balances” include the principal + previous days’ interest + new purchases
Credit Card Interest Calculation Example
Let’s assume the card’s total daily balances equal $500, there are 30 days in the billing cycle, and the card’s APR is 15%.
Average Daily Balance = $500 / 30 days = $16.67
Daily Periodic Rate = 15% / 365 = 0.04%
Interest Charges = $16.67 * 0.04 * 30 = $20.00 for the whole billing period
Types of Interest Rates
It is important to note that every credit card – with the obvious exception of charge cards – has a few different types of APRs, which are distinguished from one another based on the types of transactions they apply to as well as the passage of time. For instance, a single credit card will have a purchase APR, a balance transfer APR, a cash advance APR, and potentially a penalty APR as well. It might also have an introductory APR for purchases and/or balance transfers that is lower than the regular rate but only lasts for a certain period of time (e.g. 6-18 months).
Card APRs can also differ in terms of whether they are fixed or variable. Variable rates change in accordance with the fluctuations of a certain index rate, such as the Prime Rate or the LIBOR Rate, while fixed rates do not.
You can read more about all of these different types of rates in our article about Credit Card Interest Rates.
How Loan APR Works
The APR on a loan, such as a mortgage or personal loan, is the total yearly cost of borrowing money from a financial institution. It’s written as a percentage of the amount being borrowed.
Unlike with credit cards, a loan’s APR usually reflects more than just the interest payments that must be made over time. It also includes certain fees, such as origination fees on personal loans and processing and underwriting fees on mortgages. Essentially, loan providers add up all the interest and fees associated with a loan and spread them out over the life of the loan. Then, they use that to quote you an APR.
Also unlike with credit cards, you typically pay loans back with equal monthly installments, which means the interest you pay won’t vary from month to month. Assuming you know how long your loan will last and what APR you’ve been quoted, you can calculate exactly how much interest you’ll pay each month and in total.
Loan Interest Calculation Example
Loan APR: 10%
Loan Amount: $10,000
Payoff Period: 5 years
You can use WalletHub’s personal loan calculator to try this out for yourself.
Key Things to Remember When Comparing Loan APRs
Loan APRs are designed to simplify direct comparison of loan offers, making it easy to contrast the cost of borrowing money from one institution to the next. At least that’s how things work in theory. In a practical sense, however, loan APRs do not always provide the basis for a direct apples-to-apples comparison for two reasons:
- When it comes to mortgages, most people do not keep their mortgage for the entire life of the loan, which skews the effective finance charges they pay.
- The types of fees that are included in an APR are not standardized. One lender might include five different fees, for example, while another could incorporate 10. It is therefore very important that you inquire as to what the APR on a prospective loan includes in order to get an accurate sense of whether it is a good deal or not.
It is also important to note that when it comes to mortgages, lenders are required to list both the APR and the interest rate associated with the mortgage on all marketing materials. This will give you a better sense of how much of your APR comes from fees.
Types of APRs
We know that APRs differ by type of financial product. For example, the APR on a loan is a bit different than the APR on a credit card because loan APRs often factor in fees. How high APRs get differ by product, too.
A single financial product can also have more than one type of APR. For instance, a credit card can have a purchase APR, balance transfer APR, cash advance APR, penalty APR, and introductory APR. It’s important to understand how each type works and when it applies so you can take steps to minimize your costs and maximize your savings.
Purchase APR
The purchase APR is the most common interest rate credit card users will deal with. It applies to balances that you carry from month to month. But you’ll never actually owe any interest if you always pay your balance in full by your due date, assuming your card has a grace period.
Introductory APR
An introductory APR is a promotional rate – often 0% – given to new customers for a certain period of time. With a credit card, an introductory APR may apply to purchases or balance transfers.
Balance Transfer APR
A balance transfer APR is a type of credit card interest rate that applies to any balance moved to the card from an account with another creditor. For example, you might move the balance of your auto loan onto a credit card. Many balance transfer cards will give you an introductory rate, usually 0%, for a certain number of months. After that, a regular APR takes effect and applies to any remaining balance.
Penalty APR
The penalty APR, or default APR, is one type of interest rate you definitely don’t want to encounter. It is an elevated rate put into place because of account misuse. For example, a credit card issuer can apply this APR to your existing balance once you become at least 60-days delinquent, meaning you’ve missed two payments. And it will take six months of on-time payments before your issuer is required to revert the rate on existing balances.
Cash Advance APR
A cash advance APR is a credit card interest rate that applies to money you withdraw from an ATM or spend via a so-called convenience check. This rate is typically higher than the card’s regular APR, and it applies right away after a transaction.
Learn more about the different types of credit card interest rates, as well as personal loan rates and even the highest savings account rates.
APR vs. Interest Rate
APR and interest rate are two very similar terms that have slightly different practical definitions. The relationship between the two terms also differs depending on whether you are talking about a credit card or a loan.
When it comes to credit cards, the actual rate at which you accrue interest will be your APR divided by 365 (days in a year) since credit card interest is assessed on a daily basis. For instance, if your APR is 15%, you’ll be charged a 0.041% interest rate on your outstanding daily balance.
With loans, things work the other way around. Rather than your APR being set and thereby dictating your interest rate, your interest rate and fees will first be determined and will combine to create your APR. Mortgage lenders are required to disclose both a loan’s APR and its interest rate in order to give borrowers a clear sense of how all of the expenses associated with the loan contribute to its overall cost.
APR vs. EAPR
APRs often function differently in theory and in practice. This phenomenon is most pronounced with credit cards, as the APR cannot take into account the impact of daily compounding (accruing interest on interest).
For most loans, on the other hand, whether or not there is a difference between the theoretical and practical APRs depends on if you keep the loan for its full term. If you do, the theoretical and practical APRs will be equal. However, if you only keep your loan for a fraction of the term – as would be the case if you sold your home a few years into a mortgage, for example – then the fees that are spread over the life of the loan for the purpose of creating the APR would be effectively front-loaded, increasing the effective APR relative to the nominal one. You’ll pay these fees upfront in both cases, but since the APR reflects the annual cost of borrowing money over the life of the loan, reducing your loan term while keeping the fees the same increases the annual rate.
With that being said, let’s explore the difference between APR and EAPR for credit cards in a bit more detail because it is slightly more complicated:
Nominal APR (or simply APR)
Your nominal annual percentage rate, which is what is printed on credit card offers and monthly statements, reflects the cost of carrying a credit card balance in the absence of compounding. Supposing your credit card has a 25% APR and you carry a $100 balance for a year, you would owe $125 by year’s end. However, the actual amount of interest (EAPR) you would pay will be more.
Effective APR (also called EAPR or simply EAR)
Your effective annual percentage rate, or simply effective annual rate, reflects the true annual cost of carrying a credit card balance. Because credit card companies calculate interest on a daily basis, it compounds over time. Again, that means the interest you incur today will apply to your balance and the interest you accrued yesterday and the day before that and so on.
As a result, your EAPR will always end up being higher than the advertised nominal APR. The higher your nominal APR, the greater the differential (or disparity) will be between your APR and your EAPR. For instance, let’s assume again that your credit card has a 25% APR, and you carry a $100 balance for a year. When that interest is compounded daily, it would translate to an EAPR of 28.39%, or 13.6% higher than the nominal APR in relative terms. Compound interest applied, your balance would grow to about $128.39 by year’s end.
APR vs. APY
You may have heard the term APY (Annual Percentage Yield). Be careful not to confuse APY with APR. Here’s an easy way to distinguish between the two: APR is interest that you pay on a loan whereas APY is interest you would earn on an investment. Also, APR is annualized simple interest. APY is calculated the same way as the EAPR and considers compounding.
What Affects Your APR?
Credit card companies and loan providers determine their APRs based on creditworthiness – or how much risk you pose as a borrower – as well as broader factors, like the health of the economy. Creditworthiness is based on criteria such as your credit history, income, and debt. Other considerations include your age, monthly housing payments, and employment status.
APRs can also be fixed or variable. If you have a variable APR, your rate could go up or down based on changes in the broader economy.
Learn more about how credit card companies determine their APRs.
How Do I Find My APR?
You can find the APR for a credit card account by looking at your cardmember agreement or monthly statements. This information should be easily accessible through your online account.
Similarly, with a loan, your APR should be readily available via your account statements and the lender’s website. You could always call customer service, too.
Learn more about finding your credit card interest rate.
How to Avoid Interest Charges
The best way to avoid interest charges is simply not to borrow. If you don’t have any debt, there’s nothing to pay interest on. That’s easier said than done, though.
Short of abstaining from borrowing altogether, you can try to opportunistically take advantage of 0% financing deals. You might be able to get 0% financing on a car, a big purchase from a major retailer, or any purchase made with a 0% introductory APR credit card. However, you’ll need good credit or better to get the best deals, and retailer financing offers often include a dangerous feature known as deferred interest.
Fortunately, you won’t have to pay interest on everyday purchases made with a credit card that has a grace period, as most credit cards do. A credit card’s grace period is the 21-25 days between a credit card’s monthly statement being generated and its monthly due date, when interest will not accrue. To benefit from the grace period, you need to pay in full each month.
Learn more about how to avoid credit card interest charges.
Ask the Experts
We asked a panel of experts to share their advice and insight with APR. Click on the experts’ profiles to read their bios and responses to the following key questions:
- What is the biggest misconception people have about annual percentage rates?
- How should consumers use APRs to compare financial products?
- Do you think the average adult knows what APR stands for? Do you think they know how annual percentage rates work?
Ask the Experts
MS, AFC®, FFC®, FBS®, Director, Center of Excellence in Financial Counseling, College of Business Administration, University of Missouri—St. Louis; Assistant Teaching Professional of Personal Finance, Department of Finance and Legal Studies, College of Business Administration, University of Missouri—St. Louis
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Associate Professor of Economics, West Virginia State University
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Department Chair in Finance, Professor and Synovus Fellow, Faculty Director of Fulltime and Online MBA Programs, Harbert College of Business, Auburn University
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Professor of Finance, Pamplin School of Business, University of Portland
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Sports and Society Research Professor of Economics, Ohio State University - Department of Economics
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CPA, MBA, Assistant Finance Professor, Business Programs Department, ACCT, BMGT, FMGT, HRM, and BOA Technologies, Columbus State Community College
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