Understanding the importance of APR (Annual Percentage Rate)
The term APR (Annual Percentage Rate) was created to allow comparison of the interest rate charged on credit cards issued by the various credit card issuers.
However, the lowest APR is not the best criteria to compare the interest rate on a credit card. A credit card with a lower APR could have the following hidden costs:
- an annual fee,
- an application fee for taking out a credit card,
- a low introductory rate which on expiry reverts to a much higher rate
- a charge for cash withdrawals from an ATM,
- other charges to make up the difference between the headline rate and the prevailing rate.
The introduction of the APR in annual terms was brought in to bring uniformity to credit card interest rate comparisons. In the past credit card issuers would advertise their interest rates either, yearly, monthly or in any other manner they saw fit. To calculate the annual interest, multiply the amount borrowed by the APR e.g. £500 (amount borrowed) and multiplied by the APR (say 15.0%) = £75.00
However, it is likely that an outstanding balance will increase by the purchase of further goods and services. Whether the minimum payment requested on the monthly credit card statement is made or whether a higher amount is repaid, not only interest on interest, but interest charges on any annual fees or fees for any missed payments, will be paid as well. So the way a credit card is used will vary from person to person. If a person always pays off the outstanding credit card balance each month he could be better off with a 9% APR than one with a 7.5% APR but which has an annual fee of £20.
- e.g. £500 x 9% = £45.00.
- e.g. £500 x 7.5% = £37.50 + £20.00 (annual fee) = £57.50
The APR calculation as shown will help to compare the cost of credit card borrowing against another credit card with a different APR.
In summary, always compare the terms and conditions imposed by the credit card issuer before applying for a credit card. This will be another of the factors in deciding which credit card to apply for instead of being influenced by a catchy headline APR.
Return to our credit card information section, or return to the homepage.