APR vs Interest Rate–What's the Difference?
The terms “annual percentage rate” and “interest rate” are often used interchangeably, but they have slightly different meanings on your credit card account. While they are similar in principle, it is important for you to know the difference between the two when selecting your credit cards. This will allow you to make a valid comparison and ultimately choose the most affordable credit card. Let’s take a look at APR vs interest rate so both terms are fully understood.
The Difference between APR and Interest Rate
The interest rate on a credit card is the cost of borrowing money expressed by a percentage rate. This is money that goes to the issuer as a payment for granting you a short-term loan. On credit cards, the interest rate can sometimes be referred to as the nominal APR. But there is also something called the effective APR. The effective APR includes this interest rate, but it also may include some of the other fees associated with the account. Your effective APR will always be higher than or equal to your interest rate.
How APR Is Calculated
Every bank calculates their APRs a little differently, but they are all required by law to keep their prices fair. This is in accordance with the Truth in Lending Act, which regulates how much banks charge their customers for interest and other fees. Those excess fees are defined in the U.S. Code, Title 15, Chapter 41, which lists the following possibilities:
- Interest, time price differential, and any amount payable under a point, discount, or other system or additional charges.
- Service or carrying charge.
- Loan fee, finder’s fee, or similar charge.
- Fee for an investigation or credit report.
- Premium or other charge for any guarantee or insurance protecting the creditor against the obligor’s default or other credit loss.
- Borrower-paid mortgage broker fees, including fees paid directly to the broker or the lender (for delivery to the broker) whether such fees are paid in cash or financed.
APR Ranges Explained
When you look at an APR for a credit card, you will most likely see a range of numbers, like 13.99% – 21.99%. This represents the lowest and highest APR possible for the credit card. People with better credit histories get lower APRs because they are less likely to default on their payments, at least in the bank’s eyes. Bad credit scores come with high risks, so banks charge more to cover themselves in the event that you don’t pay your bills.
How APRs Change over Time
Variable APRs can change while you are a cardholder, and even fixed APRs can change under certain circumstances. The credit card company will send you a letter in the mail 60 days in advance to let you know a change is coming. This gives you time to prepare for the charges. If you never have a balance in your account, then this change won’t have very much of an effect on you.
There are several reasons why a credit card company may increase your APR. If your credit situation has changed and your credit score has dropped, your company may reevaluate your application and assign a different rate to you. The company may also raise rates across the board due to fluctuations in the economy or their own financial situation.
How to Get a Low Interest Rate and APR
If you want the best rate you can find, look for low interest credit cards. These are usually reserved for people with high credit scores, so you may need to build your credit before applying. You can avoid paying any financial penalties if you pay off your entire balance on time every month. If that doesn’t happen though, having a low interest card will help you avoid painful interest charges.