What Is APR?

Editor's Note: This story was first published on August 11, 2017, and updated on March 15, 2018. Annual percentage rate (APR), is the interest rate lenders charge when you borrow money. APR incorporates the interest the bank or finance company will charge, plus fees and other costs, into a single percentage rate that helps you determine how much the loan or credit card will actually cost you in a year.

How Is APR Calculated for Credit Cards?

Credit cards can have more than one type of APR, and the different types of credit card APRs are tied to what you do with the card. When you look at your credit card agreement, you may see language about these types of APR:

1. Introductory APR

Credit cards and retail cards will often offer a low or zero percent APR in order to give you an incentive to apply for a credit card. This promotional low rate for all new purchases is available for a set amount of time-at least six months but sometimes as much as 18 or 24. When the introductory period ends, the APR will increase and so will the cost of using the credit card. Your APR may also increase if you violate any of the terms of the credit card agreement, such as failing to pay on time, paying less than the minimum monthly payment amount or spending over your credit limit.

2. Balance transfer APR

If you move a balance from one card to another, you'll likely be charged a balance transfer fee, which could be 3% or more of the balance amount transferred. I n addition to the fee, the amount of the balance transfer could be subject to a special APR, and not to new purchases, which would have a separate purchase APR. Some balance transfer deals initially only charge you a fee, and for an introductory period, will feature a 0% APR for the amount transferred. After that introductory period, the APR will shoot up to whatever the balance transfer APR is.

3. Purchase APR

This is the annual percentage rate that applies to purchases you make with the card. If you use your credit card to make a purchase and pay off the full balance in the next month, you can avoid paying interest.

4. Cash advance APR

When you use your credit card to withdraw cash from an ATM, this APR will apply to the amount you withdraw. Typically, cash advance rates are higher than purchase rates. As soon as you take the cash advance, you will begin paying interest on the amount.

5. Penalty APR

Most credit card agreements include a penalty APR that the company will charge if you fall behind on payments by 60 days or more. All the balances on your account will be subject to the penalty rate, which is often much higher than other interest rates. The average penalty APR is about 30%.

How APR is Calculated for Loans

Remember, the interest rate is the money the lender charges to allow you to use their funds, however, it's not the only cost of borrowing money. APR is made up of all of these other costs plus the interest rate, giving you your total cost of borrowing money or using credit. For example, mortgages also come with points (fees paid to lenders at closing), broker fees and other charges you will need to pay in order to secure the loan. APRs for dealer-underwritten auto loans usually include compensation for the dealer handling the financing. The APR takes these additional costs into account, which is why the APR is typically higher than your interest rate. Nevertheless-and this is important-the interest rate is an incredibly important number when it comes to using credit. Depending on the type of loan you get, the interest rate can even change over the life of the loan. This is common with home loans, which can either be fixed-rate mortgage or adjustable-rate mortgage. It's important to remember that interest compounds. That means that the interest charges add to the balance you owe, so your balance can grow during the month or from month to month, even if you don't make any new charges. Some people end up paying interest on the interest, which can really cause debt to snowball.

What Is The Schumer Box

Information about the various interest rates and fees associated with a credit card can be found in the "Schumer Box" (see example below). The Schumer Box was created to provide consumers with a simple and standardized display with all the pertinent details about a credit card. Charles Schumer, who was a New York congressman at the time (and now a senator), spearheaded the legislation that required credit card terms to be presented in this way so consumers could compare rates and fees, and have an easier time evaluating the total cost of credit. In 2009, the Credit Card Act expanded the concept of the Schumer Box, and added a requirement that credit card companies provide clear information on all credit card statements about how much you will pay in interest and fees if you opt to pay only the minimum payment amount due every month. ** PLEASE DESCRIBE THIS IMAGE **

Can you Avoid Paying Interest on Credit Cards?

Yes, by all means! With almost all credit card accounts, you get a grace period, which is the period between the end of a billing cycle and the date your payment is due. It is typically 21 days. You avoid paying interest by paying the full balance listed on your credit card statement. The grace period applies to purchase charges. Some balances, like cash advances and balance transfers, don't have a grace period, so sidestepping paying interest is not likely.

How Fast Can Credit Card Interest Add Up?

If the due date for your payment rolls around and you don't have the funds to pay your balance in full, you will be charged interest on the remaining balance. These finance charges can add up tremendously fast due to compounding (discussed above). Interest will be charged on everything you owe-the unpaid amount you owe, the previous month's interest and on whatever new purchases you made.

How Minimum Payments Impact Finance Charges

You purchase a big screen TV and a new sofa for $2500 on a credit card with an APR of 22%. If you commit and plan for paying this off in 12 months, your monthly payments will be about $235, and you will pay about $308 in total interest charges. On the other hand, if you pay only the 3% ($75) minimum payment required (every credit card spells out the minimum payment requirements), you would still be paying on this purchase more than 4 years later. Not only that, you would pay $1,399 in interest, making the total cost of this purchase $3,899, 55% more than the original sticker price.

APR: How Much Interest Will You Pay on your Credit Card?

Credit card purchases: $2500
APR: 22%
Minimum payment required: 3% of balance

Scenario 1: Make a plan to pay off your debt in a set amount of time to minimize finance charges.

Monthly payment: $235 Total interest paid: $307 Time to pay off: 12 months Total cost: $2807

Scenario 2: Pay the 3% minimum payment every month.

Monthly payment: $75 Total interest paid: $1399 Time to pay off: 52 months Total cost: $3899