When it comes to credit cards, the annual percentage rate is probably the most important number to know. But what exactly is an APR — and what does it mean for your bottom line?
Any time you borrow money from a financial institution, you are charged interest on the outstanding balance. Credit cards are no exception.
If you carry a balance from one month to the next, you are charged interest on the total. Most credit cards compound interest daily or monthly, and the balance fluctuates month-to-month, so banks simplify your interest rate as the APR. This is a representation of how much interest you are charged over the course of a year. Even so, the APR is also used to calculate the amount of interest you owe each billing cycle.
Credit cards also have more than one APR associated with them. For instance, you might be charged a different APR on cash advances. Or if you miss a payment, your rate might switch to a penalty APR. It’s important to review your entire credit card agreement and understand what APR you will pay under which circumstances.
How Card Issuers Determine APR
Every credit card issuer sets a card’s APR according to its own particular set of standards. However, there are two main factors issuers consider when determining the APR: the prime rate and your creditworthiness. The prime rate is the best interest rate that banks charge their ideal customers. It’s closely tied to the federal funds rate, which is what Federal Reserve banks charge each other to borrow short-term loans.
Prime rate: The first factor that impacts credit card APRs is the general economic climate. “Most credit cards have floating or variable APRs, which move with the markets, an index or the prime rate,” says Jennifer McDermott, consumer advocate with personal finance comparison website Finder.com.
[Read: Best Low-Interest Credit Cards of 2018.]
The majority of credit card issuers use the Wall Street Journal prime rate as the benchmark for interest rates. According to Yves-Marc Courtines, a chartered financial analyst and a principal at Boundless Advice LLC, banks set a prime rate internally and then publicly announce it. The Wall Street Journal surveys the largest 30 banks and publishes a consensus. “Generally speaking, major banks set their internal prime rate as 3 percent higher than the federal funds target rate,” says Courtines.
McDermott adds that if the prime rate changes, credit cards with variable rates will reset the APR. “The new APR will be the prime rate plus the bank’s margin. So if prime rate is 5 percent and the bank’s margin in 10 percent, the cardholder will pay a 15 percent interest rate,” she says.
Creditworthiness: Secondly, credit card issuers will look at your financial situation to determine the final APR offered to you. This includes your credit history, income, job history and more. And though several factors are evaluated, generally, the higher your FICO credit score, the lower your interest rate.
FICO scores are broken down into the following ranges:
— Exceptional: 800 to 850
— Very good: 740 to 799
— Good: 670 to 739
— Fair: 580 to 669
— Poor: 300 to 579
Applicants with very good and exceptional credit scores will usually be offered the lowest APRs available. On the other hand, those with fair or poor credit will either be stuck with high APRs or won’t be approved for a credit card at all.
[Read: Best Credit Cards for Bad Credit of 2018.]
If you’re evaluating credit card APRs, you might be curious whether the rates you’re offered are competitive. According to the Federal Reserve, the average credit card rate for all accounts is 13.63 percent as of February 2018.
How to Keep Your Interest Costs Down
No matter what your credit card APR is, there are ways to keep interest costs down. Below are a few tips you can follow to avoid paying interest.
Pay off your balance every month. The easiest way to avoid paying interest on your credit card is to never carry a balance. If you pay your entire balance off each month, you’ll never pay a dime of interest. Make sure that when you swipe your card, you have the money to cover the bill, and avoid spending beyond your monthly income.
Pay on time. Even if you can’t afford to pay your balance in full, you should always pay the minimum due by the payment due date. Missing payments not only harms your credit, but also results in a higher penalty APR — more interest you have to pay on purchases. Usually, penalty APRs are applied to future purchases, but if you fail to make a payment after 60 days or more, that APR might be applied to your current balance as well. Credit card issuers are required to reinstate your previous APR on your current balance if you make on-time payments for six months. However, future purchases could be charged at the penalty rate indefinitely.
[Read: Best Balance Transfer Credit Cards of 2018.]
Take advantage of zero percent APR offers. Credit card issuers often entice new customers by offering zero percent APR for an introductory period. This rate can apply to new purchases or a balance that’s transferred from another card.
“To really maximize this interest-free period, put a plan in place to pay off the debt before the introduction ends and the regular APR kicks back in,” says McDermott. “If that’s not possible, take the post-intro APR into consideration when choosing a provider. Otherwise you could end up with a higher interest rate than your original card and be in a worse situation than before.”
Ask for a lower rate. Finally, if you’re paying a sky-high APR or simply want to save money on interest, sometimes all you have to do is ask.
“Most credit cards will offer to lower your interest rate for a period of time,” says Courtines. He recommends calling a customer service representative and asking politely. Be sure to emphasize that you’ve been a good customer — as long as that’s true — and would appreciate a lower rate.
And if they say no? Call back and try talking to a different rep.
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What Is a Good Credit Card APR? originally appeared on usnews.com
