Before you take out a credit card, experts generally advise you to compare purchase annual percentage rates.
But what is that?
This number—commonly abbreviated as “purchase APR”—reveals how much borrowing money will cost you over time. Here’s a closer look.
The Basics of Purchase APR
How does APR work on a credit card? APR stands for “annual percentage rate,” and it represents the annual cost of borrowing money relative to the balance.
Purchase APR is the APR applied to any purchases you make on your credit card.
The APR on a credit card indicates how much it costs per year to borrow money, but charges are usually assessed on your account each month. If you see “fin chg purchase” on your credit card statement, this stands for “finance charge for purchases.”
You also might wonder, “Does APR get charged daily?” The term “annual percentage rate” can be misleading. Although your APR tells you the annual cost to borrow money, the interest on your existing balances is usually calculated and compounded daily.
When interest compounds, the interest your account generates is added to the total amount you owe. The new, slightly larger balance then generates interest. Because this process happens each day, it’s easy for credit card balances to quickly get out of control.
Do I Pay APR if I Pay on Time?
You may be able to avoid paying APR on your purchases.
If you pay off your credit card balance on time and in full each month, you generally won’t have to pay additional interest and fees. The APR is only applied to the balance you carry from month to month. However, some cards charge interest right away, so read your terms to be sure purchases don’t start accruing interest from day one.
Even if you can’t pay off the whole statement balance, it helps to pay more than the minimum payment if possible. The faster you can chip away at your principal balance, the less you’ll pay over time.
Purchase Annual Percentage Rate Isn’t the Only Kind of APR
When most people talk about the APR on a credit card, they’re talking about the purchase APR. However, there are a few other types of APRs to consider.
For some credit cards, different types of APRs apply in different circumstances. Here are examples of other types of APRs:
Introductory APRs
Many credit card companies will offer introductory 0% APRs. For instance, if you open an account, you may have 0% interest on purchases for six months.
This means that if you pay the full balance before the six months are up, you won’t owe interest.
Balance-Transfer APRs
A balance transfer is when you take the balance on one credit card and transfer it to another. Most credit card companies charge a different APR for balance transfers.
This rate is usually lower than the purchase APR. However, keep in mind that in many cases, you’ll also owe a balance-transfer fee. This is usually a small percentage of the total balance you’re transferring.
Cash-Advance APRs
A cash advance lets you access cash from your credit limit. Cash-advance APRs are often much higher than purchase APRs, and cash advances sometimes come with significant fees.
Penalty APRs
Some credit card companies have what is known as a penalty APR. This is a higher rate they charge if you make late payments or otherwise violate the terms of your agreement.
What Is a Good Purchase APR on a Credit Card?
A good purchase APR is generally one that’s below the national average, which is around 22%, according to the latest data from the Federal Reserve.
However, purchase APRs exist in a wide range. APRs may fall anywhere from about 12% to more than 30%. The lower the purchase APR, the better.
What Determines the Purchase APR on a Credit Card?
Each credit card issuer has the freedom to set its own APRs. When doing so, issuers will usually look at factors such as:
- Your credit score
- Your income
- Your debt-to-income ratio (DTI)
- Your overall payment history
- Whether you already have a relationship with the card issuer
Broadly speaking, credit card companies set individual purchase APRs based on risk. The more likely you are to have trouble repaying, the higher your APR is likely to be.
When setting your APR, credit card companies also look at broader economic factors. One of the most important is the prime rate. This is a baseline rate that banks use when determining loan rates.
Understanding APR: A Key Part of Responsible Credit Use
The world of credit cards can be disorienting, especially if you haven’t opened an account previously. However, it’s worth taking the time to learn what a purchase annual percentage rate is and the cost of borrowing. If you do, you’ll be well-equipped to stay out of debt trouble and make your credit cards work for you.
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