Credit cards allow people and businesses to make purchases with a promise of future payment. This type of credit is offered by banks and other financial institutions.
Most credit card services are designed to work with a third-party institution such as Visa or MasterCard. All lines of credit are extended with a built-in interest rate that is usually figured on an annual basis. The annual percentage rate, abbreviated as APR, determines what amount of interest the cardholder will pay on any principal balance that is carried over from one billing cycle to the next.
How APR Is Calculated
The APR reflects the yearly amount of interest that is charged on a credit card. If, for example, a line of credit carries an interest rate of 10%, then the outstanding balance at the end of each billing cycle, usually a calendar month, is charged 10%. If the balance on the credit line is $100, the amount of interest added is $10.
However, most credit card companies charge interest based on the average daily balance. The daily periodic rate is the APR divided by 365 days. This total is then multiplied by the average daily balance. This new total will vary depending on how many days are included in the billing cycle. This is because not all months have the same number of days.
Most credit card companies have a grace period of around 20-30 days. This means that no interest will be charged on the outstanding principal balance if it is paid in full before the grace period ends. This due date is clearly shown on the cardholder's monthly statement.
Variable And Non-Variable Rates
Variable rate lines of credit are set when the account is opened. If the U.S. Prime Rate goes up or down, the APR on the cardholder's account will also fluctuate. This may occur monthly or quarterly.
A non-variable rate is also set when the offer of credit is extended. This rate is not subject to change based on an external reference rate, but the issuing company does reserve the right to change the percentage based on card use statistics. If the cardholder maintains a high monthly balance, the rate may increase.
Different Rates On The Same Card Account
Some credit card issuers offer new customers the opportunity to enjoy a very low APR for a limited time when the account is first opened. There may also be a different APR for balance transfers than those associated with purchases. Some credit card offers come with a special APR for cash withdrawals at an ATM.
Individuals and businesses can save money by opening a new line of credit that carries a zero APR on balance transfers. They can transfer the outstanding principal balance on one card to the new account, meaning that there will be no interest accrual on the amount transferred.
Finding The Lowest Interest Rates
You may receive offers of low interest rates for a new account. Credit card companies look at your credit score and make determinations about percentage rates based on past spending history and creditworthiness. Some credit card offers include low interest rates on certain types of purchases only. Airfare and other travel expenses may be charged a different rate than groceries or gasoline. Before entering into an agreement with a credit card company, it is always a good idea to review the different APR calculations stated on the offer.
