Today’s credit cards offer incredible rewards and benefits. You can use a new credit card to earn cash back bonuses and even score free insurance for a rental car. However, it’s important to choose the right card for you, which means comparison shopping.
When looking for a new credit card, one of the biggest factors to consider is the annual percentage rate (APR). If you’ve shopped for a mortgage in the past, you might have heard of APR and know that it differs from the interest rate.
However, credit cards work differently. Here’s what you need to know about APRs and interest rates.
What’s the difference between APR and interest rate?
The interest rate refers to how much you pay to finance a purchase. Your APR is an annualized representation of your interest rate; it’s the cost of interest plus any fees. For certain lending products — such as home loans — the APR more accurately describes the total cost.
APR exists because of the federal Truth in Lending Act (TILA), a federal law passed in 1968 to protect the everyday consumer when they borrow money. By providing the APR vs. interest rate, the consumer has a clearer idea of the true cost of the loan amount. Seeing a higher APR is the norm, since it includes additional costs such as origination fees, discount points, mortgage insurance, etc.
With certain lending products, you could see a lower APR and a higher interest rate, like with the adjustable-rate mortgage (ARM). This is because the quoted APR only holds for a certain portion of the loan term. Thankfully with the Truth in Lending Act, lenders are required to let the consumer know if their monthly payments could increase over the years.
Credit cards, however, don’t operate the same way. Because credit cards tend to have fewer fees than mortgages, you don’t have to worry about broker fees or closing costs. When it comes to credit cards, the APR and interest rate are the same thing and the terms can be used interchangeably.
When choosing between two credit cards, looking at the APR will help you determine how expensive the card will be. The higher the APR, the more interest you’ll have to pay.
The APR for different types of purchases
With credit cards, the APR you’re charged depends on the type of transactions you complete, such as:
- Purchase APR: The purchase APR is what you pay when you buy things like groceries and clothes. Depending on the credit card, the purchase APR can be as high as 25% or more.
- Introductory APR: Some credit cards offer a special introductory APR that’s lower than the typical APR. You can enjoy the introductory APR for a set period — usually six to 18 months — before paying the regular (and higher) APR.
- Balance transfer APR: If you transfer a balance from one credit card to another, the total is subject to the balance transfer APR.
- Cash advance APR: If you take out a cash advance with your credit card, you’ll pay a separate APR. A cash advance APR tends to be higher than the purchase APR.
- Penalty APR: If you’re late with your payment, you might be hit with a penalty APR. The penalty APR is a higher rate that will apply to new transactions.
You can find the various APRs of a credit card in what’s known as the “Schumer Box,” a legally mandated table that lays out a card’s rates and fees in the terms and conditions.
Example Schumer Box for the Quicksilver® from Capital One® card
How APRs are set
The interest rate on your credit card is likely based on the prime rate, what banks charge their best customers. Typically, it’s three percentage points higher than the federal funds rate, which is set by the Federal Reserve.
Credit card companies charge a prime rate with a variable percentage rate. The interest rate you receive depends on your credit record. The lowest rates shown in the Schumer Box are for cardholders who have excellent credit scores.
If your credit is less than ideal, you might qualify only for the highest rate listed. For example, if you’re blessed with great credit, you’d likely qualify for a lower rate with the Quicksilver® from Capital One® card, maybe 16.24%. If your credit score is not so great, you might be stuck with the highest rate, 26.24%.
How to avoid paying interest on your credit card
If you carry a balance on your credit card, the card’s APR is a big deal. A high APR causes your unpaid balance to balloon, making it difficult to pay off your debt.
However, if you use your cards strategically, the APR won’t matter. Most credit card companies offer a grace period on new purchases. During the grace period, interest won’t accrue until after the due date of your monthly statement.
To avoid paying interest fees, pay off your card’s statement balance in full each month. With this approach, you can focus on the card’s other benefits and rewards rather than worrying about the interest rate.
Understanding your interest rate
While the APR and the interest rate are two very different things when it comes to mortgages, they’re the same thing when you’re talking about credit cards. Understanding how APR works can help you choose the right credit card and avoid paying interest charges.
Before applying for a credit card, make sure you compare several credit cards to ensure you’ll get the best rewards and best rate.