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How Credit Card APR is Calculated |
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by: Debbie Dragon
If you've had a credit card for more than a month, you probably have noticed that your purchases are charged interest. For cards without a grace period, purchases are charged interest from the moment the purchase is made; while credit cards with a grace period (typically 21 days or so) at least give you some time to pay off the balance before they begin charging interest on the remaining balance. What you may not fully understand is the calculation of APR and how it includes the finance charges.
Every Credit Card Company Uses a Different Method of Calculation
There is no one-size-fits-all program for calculating your APR. By law, you have to receive a written statement from your credit card issuer regarding how much you are charged in interest, and the method they're using to calculate the interest. It's typically written in a light-weight paper booklet that you receive when you first receive the card – and then receive again with every change to the terms of your card.
APR Calculation May be Fixed or Variable
If you are one of the lucky individuals to have gotten a fixed interest rate credit card that has actually remained fixed throughout all of the economic downturns, your interest rate is whatever it was stated to be when you opened the account. Other credit cards charge a variable interest rate which is based on the prime rate, plus anywhere from 2 to 7% more – a number selected by the bank and often a result of your personal credit score and payment history. The variable rate tends to fluctuate greatly, depending on circumstances of the economy, as well.
Outstanding Balances Charged the Periodic Rate
Your annual percentage rate (APR) is divided by the number of billing periods in a year (typically, 12 months). A 24% APR is divided by 12 months to give you a periodic rate of 2%. This periodic rate is multiplied by your outstanding balance to get the periodic rate for the month. It's not as simple as taking your full balance owed on the credit card and multiplying it by the periodic percentage rate though. There are a number of methods used to determine how much of your total balance is charged the periodic rate:
• Adjusted Balance: This is one of the ideal methods of calculation, because your balance is adjusted to reflect the payments you made during the billing cycle. It does not increase your balance that will be charged the periodic rate for any purchases made within the same billing cycle. If your balance was $2,200 and you made a payment of $200 during the billing cycle, and charged $140 during the same billing cycle, you will be charged the periodic rate on a $2,000 balance.
•Average Daily Balance: For credit cards using the average daily balance method, the balance is determined by adding the balances on each day of the billing cycle and then dividing them by the number of days in the billing cycle to get the average daily balance on the card. Payments you make are subtracted from the balances and purchases are added.
•Two-Cycle Average Daily Balance: This method doesn't account for your payments right away, which means if you start making larger payments to reduce your balance, you're not going to see a big different in the amount you're paying right away. The account balance on each day of the last two billing cycles are added and divided by the number of days in those two billing cycles.
•Previous Balance: This is figured by applying the periodic rate to the beginning balance at the beginning of the billing cycle. Your purchases and payments made during the same billing cycle will not affect this method's calculations.
•Ending Balance: The ending balance at the end of the billing cycle is the only thing that matters in this calculation. Your purchases and payments made within the same billing cycle won't affect this methods calculation, unless it affects the actual balance on the last day of the billing cycle. What's difficult about this method is that the billing cycles of credit cards are not an exact day each month – many have billing cycles that are “between 20 and 25 days in length” so you will never know which day they are calculating the balance, but you can guess they're picking a day when the balance is at it's highest if you've just made a payment!
Understanding how your credit card calculates your APR charges is important to selecting a card with the best rates to keep your costs of borrowing money lower. With the upcoming credit card reform, hopefully things will become easier to understand for consumers and more affordable for those who are making their payments on time.
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Credit Card Articles > Fees and Penalties > How Credit Card APR is Calculated
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