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Credit card APRs and why they are so important

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Every credit card comes with an APR. If you’re applying for a credit card it’s important to understand how credit card interest works and what the APR means. This is because it will dictate how much it will cost you to repay your debt.

What is an APR?

APR stands for annual percentage rate. The APR is what your borrowing will cost you each year. It’s expressed as a percentage.

Every type of borrowing product, such as a mortgage, loan or credit card, has an APR. The idea is to help you compare different products easily and on a like-for-like basis.

In general, the lower the APR, the less interest you pay and the better the deal is. A typical credit card APR tends to be about 18 or 19%.

What is credit card interest?

If you borrow money on a credit card, you’ll be charged interest.

For example, if you borrowed £200 and the interest rate was 10% a year, you’d need to repay £220 to clear the debt during that time.

You can avoid paying interest by paying off your entire credit card bill in full each month. Depending on when you make a particular transaction, you’ll benefit from up to 58 days interest-free.

If you don’t pay off your bill in full each month, interest will be applied to your balance. If you don’t pay anything on your credit card, your debt can grow quickly. This is because of compound interest – interest charged on interest.

Credit cards normally charge different interest rates for:

  • purchases

  • balance transfers

  • money transfers

  • cash withdrawals.

The summary box on the information leaflet which comes with a credit card will include the interest rates charged.

How are credit card APRs calculated?

Credit card APRs take into account the purchase rate of interest on a credit card and any compulsory fees, such as an annual fee.

Credit card APRs are always calculated using the following assumptions:

  • you have a credit limit of £1,200

  • you spend the full £1,200 on the first day, and then don’t spend anymore

  • you pay the money back in equal and regular instalments over the year.

The APR is calculated as follows:

  1. The interest paid over a year plus the annual fee

  2. Divide by the amount you borrow (i.e. £1,200)

  3. Divide by the total number of days in the loan term

  4. Multiply by 365 to find the annual rate

  5. Multiply by 100 to convert annual rate into a percentage.

However, borrowers don’t have to worry about doing complex calculations to work out a credit card APR – the credit card company does it for you.

What is not included in the APR?

Credit card APR calculations do not include:

  • non-standard charges (i.e. late payment fees)

  • interest on other transactions apart from purchases (i.e. balance transfers or cash withdrawals)

  • compound interest.

Because all credit cards use the same assumptions to calculate an APR, and do the same calculation, comparing credit cards is fairly simple for borrowers.

What is a representative APR?

When a credit card provider advertises a credit card, the APR it quotes is the ‘representative APR’. But you won’t know what rate you’ll be given until you apply for the card.

The representative rate must be given to at least 51% of people who successfully apply for the credit card.

Other people who are accepted for the credit card will be offered a ‘personal APR’ based on their circumstances. This is likely to be higher than the representative APR.

Personal APRs take into account your credit history, income and other personal details.

The representative APR will typically be the same as the purchase rate if there are no mandatory fees on the card.

What is a go-to APR?

Some credit cards offer 0% interest on purchases, balance transfers or money transfers for a set period of time.

At the end of this period, you’ll be charged interest. This is often referred to as the go-to interest rate or go-to APR.

If you don’t repay your whole credit card debt by the time the 0% interest period ends, you’ll pay the go-to APR.

What is a variable APR?

Most credit card APRs are variable. This means the credit card provider could change the APR on the card. It might do this in response to changes to the Bank of England base rate, or if you don’t make payments on time.

APRs on personal loans or mortgages are more likely to be fixed, and so won’t change for a stated period of time.

Why do APRs matter?

The APR on a credit card is important as it’s the cost you pay for borrowing money.

If you pay off your credit card bill in full on time each month, the APR is less important as you won’t pay any interest. However, it’s still a good idea to have a card with a low APR in case your circumstances change and a time comes when you have a balance on your card incurring interest.

Different types of credit card and APRs

Some credit cards have higher or lower APRs because they’re designed for certain uses.

Most mainstream credit cards don’t have an annual fee, so APRs basically compare purchase interest rates.

‘Premium’ credit cards are most likely to charge an annual fee, so on these cards the APR will be higher than the purchase interest rate.

0% purchase or balance transfer cards are designed to offer an interest-free period. At the end of this period the card reverts to the go-to APR.

Credit building credit cards have high APRs. Used correctly (i.e. paying off your balance each month), this type of credit card can improve your credit score.

But if you carry a debt on these cards they can be very expensive.

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