Smart borrowers and credit card users know how to calculate APR, which is the annual percentage rate on all debt-related products.
Learn How to Calculate APR
Although this rate is called "annual," credit cards and loans in particular apply APR to balances in monthly installments. APR is a good point of comparison to look at when shopping for new credit cards, auto loans and mortgages. The rate is a key factor that differentiates one financial product from another, and is even pertinent to certificates of deposit, checking accounts and savings accounts.
APR seems deceptively simple at first, but it's complex because an annual rate is divided into 12 and applied to outstanding balances. Yearly account fees are also added to the calculations, either divided into 12 or in one lump payment depending on what the credit-card company or lender specifies.
To figure out the monthly interest on a credit card with an APR of 7.5 percent, divide 7.5 percent by 12, which is 0.625 percent. The monthly interest is multiplied by the outstanding balance on the billing date, and then that amount is added to the balance to arrive at the total due for that month. If the cash portion of the balance on that 7.5 percent APR card were $100, then the monthly interest payment would be 62.5 cents, and the total balance after interest has been charged would be $100.625, which would likely be rounded off to $100.63.
Calculating APR on credit card accounts can get confusing because interest is typically charged when balances aren't paid in full. So with the example of the 7.5 percent APR card mentioned above, the 62.5 cents would be the monthly interest charged on $100 if it were carried over from the previous month. Now if this month's charges were a total of $100, and you decided to pay half of it, next month you'd pay interest on the $50 you carry over. That would
add up to $50.3125, which would likely be rounded off to $50.31. That amount would be added to the latest month's charges, only without any interest applied to the new interest charged. If the latest month's charges are $100, then the total due is $150.31.
This kind of numerical breakdown shows you how you can potentially save money by paying all credit card balances in full and on time. Knowing how to calculate APR has value in budgeting; if you can't afford the interest rates that accumulate from carrying balances over the months, you'll want to hold off on adding new charges to card accounts until you can pay off the balances. Similarly, knowing how to examine APR numbers may make you think twice about whether to work with a debt consolidator, a service that aggregates all of your credit card and borrowing balances into one account with one interest rate.
APR often starts out at a low rate for the first six months after a credit card account is opened, and then goes up to an extent based on the cardholder's payment habits during the initial teaser period. The APR can go up if the accountholder accumulates more borrowing capacity by opening new accounts. The APR can also change if the cardholder's credit score changes, which would happen if any accounts become delinquent or go to a collections agency.
Know the Terms
Rather than let yourself be blindsided by rate increases after they happen, learn your credit card issuer's policy for determining interest by reading the terms and conditions for every account you own. That goes for brand-new cards and ones you've had for years, because federal laws governing credit-card rate setting policies have changed in recent years and issuers have adjusted their terms and conditions as a result. Before you apply for any new card or loan, be sure to carefully read all the terms and conditions for that financial product.