How To Calculate APR

Discover How To Calculate APR And Save Money On Interest

Knowing how to calculate APR helps you to know the true cost of your credit card. The "Annual Percentage Rate" (APR) is the rate of interest charged on your credit card's balance shown as a yearly rate.

To calculate the monthly finance charge, the APR is divided into a periodic rate, usually daily. The daily interest rate is obtained by simply dividing the annual rate by the number of days in a year.

Example: 21% / 365 = 0.0575342%

For added clarification in understanding how to calculate APR, here's how one major credit card company performs its annual percentage rate calculation to determine the monthly interest charge:

"For each day, interest is calculated by multiplying the total amount of the interest bearing balance you owe that day by the interest rate or rates in effect for that day (that is the annual interest rate or rates divided by the number of days in the year). We add together all the interest charges for each day in the statement period and this is the total interest we charge your in that period."

Knowing how to calculate APR also involves knowing how the card companies determine "the total amount of the interest bearing balance you owe."

Balance Computation Methods

Different methods are used by the credit card companies for calculating your account balance. The method they choose to use must be indicated on your monthly credit card statement and in the cardholder agreement; however, you will likely have to sift through the fine print for the information.

You see, the card companies love to use fine print because they don't really want you to know this information. They are secretly hoping you'll accept the method that works best for them.

One of the following three balance computation methods is used by most credit card companies:

1. Average Daily Balance

This is the most common method used to calculate the balance, but it is not the most advantageous to the cardholder.

Your balance from each day in the billing period is simply added up and the total divided by the number of days in the billing period. Any payments or credits to your account for the month are deducted, but purchases are often not included when calculating.

2. Adjusted Balance

This method offers the most advantage to the cardholder of the three. It's the method to look for when comparing credit cards and interest rates.

The card company just takes your outstanding account balance at the start of the billing period and subtracts any credits or payments. For instance, if your starting balance was $1200 and you made a payment of $350, you would only be charged interest on the remaining $850. Purchases made during the billing period are usually not included.

3. Two-Cycle Balance

This balance calculation method offers you the least advantage of the three and should be avoided, if possible.

It works like the Average Daily Balance method, but it takes into account your balance from each day in the prior TWO billing periods instead of just the most recent period. This can have a direct effect on the amount of interest you will need to pay since the daily balances in the earlier of the two billing periods will often be larger which will increase the average daily balance figure.

Variable Or Fixed Interest Rates

Here's something else to consider when calculating annual percentage rate: the interest rate on a credit card can be either variable or fixed.

A variable interest rate is linked to what's called an economic indicator, such as the prime lending rate, and it will fluctuate with the nation's economy. Whereas, a fixed interest rate doesn't fluctuate with the economy. Instead, it's set by the credit card company. But, don't be fooled by the word "fixed," as the rate that's set is anything but unchangeable. The card issuer can choose to alter your rate at any time just as long as they notify you in advance.

Depending on the terms of your cardholder agreement, your credit card interest rate will also increase if you send a payment in late, or if you should happen to miss a payment. The card companies use late or missed payments as an excuse to increase your rate, sometimes dramatically.

As one major card company's agreement states, "You must then pay interest on all purchases and fees shown on that month's statement and on all new purchases and fees, from the transaction date until we receive your payment for the total amount you owe" -- Ouch!

A word to the wise: NEVER miss or ignore a payment date.

Knowing a little bit about how to calculate APR will help you to compare credit card rates so you can always get the best credit card for your needs.

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