Calculate the APR on a Credit Card

The federal Truth in Lending Act mandates that all lenders, including credit card companies, must disclose the APR (annual percentage rate) on the monies loaned. All of the components needed to compute your APR are listed in your credit card agreement. You can use your APR to calculate the interest you owe on your credit card balance for the month. It’s important, however, to understand the factors that will increase your monthly interest calculation.

Steps

Understanding Credit Card Terms

1. Read through your credit card agreement. You will receive the agreement when you get your credit card in the mail. A copy of the agreement will also be sent with your monthly statement. You’ll also have access to the information online. The agreement has all of the factors used to calculate your Annual Percentage Rate (APR).
2. Understand APR and why it is important to you. The Annual Percentage Rate (APR) is used to calculate the interest you owe on your credit card balance. If you understand how APR is applied to your account, you can take steps to reduce the interest cost on your balance.
3. Review how interest is calculated on a loan balance. A credit card balance is a loan. The basic formula to calculate interest on a loan is (Interest rate) multiplied by (account balance) multiplied by (period of time). With credit cards, the APR is used for the interest rate variable in the formula.

Calculating APR

1. Verify your fixed annual percentage rate. Your credit card agreement may specify a fixed rate of interest you are charged each year. While the rate may be fixed, read your agreement carefully.
   • You may find that the fixed rate is not guaranteed for the entire time you use the credit card. An interest rate change may be triggered by a change in bank interest rates, or triggered by some other event.
   • Assume that your fixed rate is 12% per year. You will be charged a 12% annual rate of interest on your credit card balances. How the balance is calculated can vary.
2. Review your variable APR. Many credit cards have an interest rate that varies. The variable rate changes based on a reference rate. The formula for your variable APR is (Margin) + (Reference rate).
   • A common reference rate for a variable APR is the US Prime Lending Rate, or Prime Rate. The Prime Rate is the rate charged to a bank’s best customers- those with the highest credit ratings.
   • The reference rate changes over time. The Prime rate, for example, changes with movements in other US lending rates. Your credit card agreement will explain how often the reference rate can change in a given year.
   • The margin is a set number that doesn’t change. That set number is always added to the reference rate.
3. Calculate a variable APR. Assume that your reference rate is the US Prime rate, which is 3.25%. Your margin is 5%. Your variable APR is (3.25% + 5% = 8.25%).
   • Say that the Prime rate declines to 2%. Your new variable APR would be (2% + 5% = 7%).
   • Assume that Prime rate increases to 5%. Your new variable APR would be (5% + 5% = 10%).
   • Read your credit card agreement to see if there is a cap on the variable APR you can be charged. In some cases, there is a cap on how much your rate can be increased in a given year.

Computing Your Monthly Interest Charge

1. Use monthly interest formula. The formula is the (Daily periodic rate) X (Account balance) X (Number of days in the billing cycle). Each component of the formula can vary.
   • Convert your APR into a Daily Periodic Rate (DPR). The formula is (ARP/ 365). If your ARP is 10%, your DPR is .027% (with rounding).
   • If you have a variable APR, your DPR will change each time the annual rate is adjusted.
   • For fixed APRs, your daily rate will stay the same.
2. Determine your account balance. For most credit cards, the account balance used is the average daily account balance. The formula is (sum of each day’s account balance)/ (number of days in the month).
   • Assume that your balance is $1,000 for the first 15 days of the month, and $2,000 for the last 15 days of a 30 days month.
   • Your average daily account balance is [($1,000 X 15 days) + ($2,000 X 15 days)/ (30 days in the month)]. That equals ($15,000 + $30,000)/ 30, or $1,500.
   • Several factors can generate a higher average higher daily account balance. Higher account balances increase the average. Also, a higher account balance for more days in a month increase the average.
   • If you had a $10,000 account balance for 1 day, it would have less effect than a $10,000 balance for 20 days.
   • Another method to calculate your average daily balance is (End of month account balance) less (Previous month’s ending balance). The interest rate is calculated based on the difference. So, if your August balance was $10,000 and your September ending balance was $12,000, your average daily balance is ($12,000 - $10,000 = $2,000).
3. Consider the number of days in your billing cycle. The credit card company will determine the last day of your billing cycle. For example, assume that billing cycle ends on the 20th of the month. Your September billing statement will be from August 21st to September 20th.
   • Assume that your DPR is .027% and that your average daily account balance is $2,000. Say that there are 30 days in your billing cycle.
   • Your interest for the month is (.027% X $2,000 X 30 = $16.44). The interest calculation would be increased by a higher APR, a higher average daily account balance, and by more days in the billing cycle.

Tips

• A credit card balance is a loan. Using a credit card is a very expensive way to borrow money. A traditional loan from a bank or credit union will have a much lower interest rate than a credit card.
• Your APR is one of the best ways to compare credit card offers. If you plan to carry a balance on your card, a low APR almost always trumps higher-APR cards. Possible exceptions are: a variable APR that could rise over time, high membership or transaction fees, or if you're going to pay your balance in full every month (and thus avoid finance charges entirely).
• Credit card companies may offer a low promotional APR to get new customers. If you sign up for a card with a low (or 0%) promotional APR, read the credit card agreement carefully. Make sure that you understand when the APR increases, and what the higher rate will be.

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Sources and Citations

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