Credit cards allow you to make purchases now and worry about payments later. With the right credit score and research, you can land a credit card that provides both rewards and a low APR, relieving the stress of high finance charges in the future if you cannot pay in full.
Finance Charges
APR, which stands for annual percentage rate, defines how much interest you have to pay yearly in outstanding balance fees. A finance charge represents a portion of that interest rate applied to one month's outstanding balance, and since one month represents 1/12th of a year, the monthly finance charge is the outstanding balance multiplied by 1/12th of the APR. For example, if you have an unpaid balance of $1,260 at an APR of 20 percent, then the finance charge is 1,260 x 1/12 x 0.20 = $21.
Monthly Payment Rate
There are 12 months in a year. The APR represents the cumulative average rate for all 12 of those months, assuming you do not accrue any late-payment penalties. Therefore, the monthly payment rate is 1/12th of your APR. For instance, if your APR is 18 percent, then your monthly payment rate is 1/12 x 18% = 1.5% of your outstanding balance each month.
Compounding
Credit card APR has the potential to compound with time. That is, if you neglect to pay off your $2,500 outstanding balance with an 11 percent APR, you will tally up a finance charge of 2,500 x 1/12 x 0.11 = $22.92. If you don't make any payments on your credit card and wind up with $2,522.92 at the end of the month, you will then have to pay interest on your interest, which is known as compounding. In addition, there may be penalty fees, including an increased APR, if you miss any of your minimum payments.
Fixed versus Variable Interest
APR may be fixed or variable. A fixed interest rate will not fluctuate with the economy, but can change with a notice given a specified number of days in advance, usually 15 days. A variable rate, on the other hand, varies according to the economy and what is known as the prime rate. Variable rates are typically three percentage points higher than the prime rate. This prime rate is a standard of interest rate measurements, published in the business section of the newspaper and online.
Achieving a Low APR
The APR your credit card gives you depends on your credit rating, previous experience with credit cards and the card to which you are applying. For example, if this is your first credit card, you will probably be hit with an APR of 15 percent or higher. With good credit, you may be able to find a credit card with a 9 percent APR. If you have poor credit, however, the APR can be as high as 30 to 35 percent.
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