Sifting through credit card offers can be daunting. There are so many numbers and lengthy explanations that it can be easy to miss the most important details.
Though it’s always a good idea to read over every contract you sign, when it comes to picking a new credit card, there is one detail consumers should try not to miss: the card’s annual percentage rate, or APR.
Taking the time to find out what an APR is and how it might affect the monthly payment is a wise step before comparing credit card offers.
What Is an Annual Percentage Rate?
Is it the same as an interest rate? Not quite. An APR is the total cost of the loan expressed in annual terms—a small, but important, distinction. A credit card’s APR might include the interest rate as well as fees for late payments, foreign transactions, or returned payments.
The APR for a loan might include fees such as an origination fee, late fees, or other administrative fees. Taking these fees into account when applying for credit helps to provide a fuller picture of what the loan may actually cost over its lifetime.
Meanwhile, an interest rate is simply the additional cost of borrowing money. It is typically expressed as a percentage of the principal.
For example, if a consumer takes out a $1,000 loan with a 10% simple interest rate and a one-year term, the person will pay $1,100 over the lifetime of the loan—the principal $1,000 plus interest of $100.
While this example is extremely simplified, it’s helpful in demonstrating the difference between a simple interest rate and a not-so-simple APR calculation. If the consumer calculates the cost of the same $1,000 loan, considering the various fees that go into the APR, the number will likely be higher than the stated interest rate.
When It Matters to Look at APR
If a consumer is comparing two similar loan or credit card offers, they may want to also look at the offer’s APR. For example, the person has two loan offers. Each is a $1,000 loan with an interest rate of 10%. With just that information to compare the two, they seem equal to each other.
A little more digging, though, will uncover that Offer A has a $100 origination fee while Offer B only has a $50 origination fee, both of which could be calculated and accounted for in the offer’s APR. With credit cards it could be that two cards have the same interest rate, but Card A has no late payment fees, while Card B carries a 20% late payment fee, making its APR potentially higher. With APR, the devil really is in the details.
How to Evaluate and Compare APRs
To get a sense of an offer’s APR, try looking at the entire terms of the contract and compare those terms to other credit offers. For a fair comparison, make sure to look at the same type of credit card or loan offer. (For example, only compare travel rewards cards, or only compare personal loans, to ensure a balanced assessment.)
Then, get into the nitty-gritty of an offer and look at the APR for different types of transactions. Even one credit card can have different APRs on different transactions. For example, one card may have a different APR on late payment penalties than it does for balance transfers or cash advances.
Evaluate each APR and compare to any other offer you may have in front of you to ensure you pick the best option for your financial needs.
APR and Credit Cards
According to the Federal Reserve, the US national average credit card APR was 15.09% in February 2020. It’s reasonable to assume that an APR at or below the national average is considered “good.” That said, qualifying for a “good” APR may hinge on a consumer’s credit score.
APR and interest rates also change alongside federal interest rates changes, so it’s important for consumers to not only rely on an average that may be out of date, but rather, look at the offer presented to them at the time.
It’s a good idea for consumers to attempt to seek out the lowest rate possible for their financial situation.
Low vs. High APR Cards
Some credit cards tend to have higher APRs than others. For example, rewards credit cards tend to have higher APRs, but provide value via perks, discounts, points, or other benefits.
On the other hand, many low-interest cards come with fewer perks, but again, can save someone money in the long run if they need to carry a balance.
Low-interest cards also tend to be reserved for those with higher than average credit scores, so they may be harder to qualify for with lower credit.
How to Avoid Paying APR
There is one way to avoid paying an APR altogether, at least with credit cards, and that is by paying off the balance each and every month. By paying off the balance a consumer will never have to pay interest or any APR-related fees.
However, it’s still a good idea to seek out a good APR offer just in case a large purchase means carrying a balance for some time.
Tips for Qualifying for a Better APR
The APR a person qualifies for typically depends on his or her individual credit score. This means, those with credit scores on the higher end of the scale might qualify for lower APRs. If a consumer has a lower credit score, that doesn’t mean they are totally out of luck, but might be offered the same card at a higher APR.
There are a few ways a person can improve their chances of qualifying for a lower APR and that starts by doing the work to improve their credit score.
One step is to check their credit report regularly for accuracy. US federal law allows consumers to get one free credit report annually from each of the three credit reporting agencies.
Consumers can also improve their personal credit scores by making debt payments on time and trying to use only 30% of their available credit at any given time. Payment history accounts for 35% of the total credit score, and credit utilization—how much of a person’s total credit is being used at a given time—accounts for 30% of the total credit score.
Reparing a poor credit score can take some time, but it’s worth the work.
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