Credit card purchases are made on money lent to your account by the bank that issued you the credit card. The money is transferred to your account and is used for either purchasing or transfer purposes. This is where interest rates come in. Interest is the cost one pays for the borrowed money. Interest rates are calculated annually and stated as a yearly rate referred to as an Annual Percentage Rate, abbreviated as APR. This is the rate used to calculate the yearly interest you will pay on your credit card, and which reflects on your statement as credit card debt.
APRs are of different types, and one credit card account could have different APRs being charged on it. This would mainly depend on your credit card issuer, as they may charge different APRs depending on the card’s purpose. You could have a card for purchases and another one for transfers. Furthermore, APRs within these stated uses could vary over time for the promotion of some transactions. A transaction within the promotional period may incur a low APR, which would increase once the set period for the promotion is over. If you carried on a monthly balance, its cost would also rise. However, punctually paid rates from promotions could easily save you money.
All APR information can be found on the comparison box on your Credit Card Agreement and on the issuer’s site. This would include whether the APR is variable or non-variable.
- How Variable APRs are calculated:
Margin (a number set by the credit card issuer) + Index (a reference rate e.g. the U.S. Prime Rate). An increase or decrease in the reference rate would also change the APR being charged onto your account.
A non-variable APR is more stable than a variable one since it is not determined by a reference rate. This, however, could be changed by the issuer based on market conditions and how you maintain your account.
Interest, however, is charged to you on a monthly or quarterly basis as appears on your statement. Since months vary in day count, card issuers use a Daily Periodic Rate (DPR) to calculate interest charged to your account. This is done by dividing the APR by 365 which is the number of days in a year. This rate is then used to calculate your account balance daily. Since your account balance may vary daily, credit issuers use different methods to decide the balance subjected to interest charges. Often, the methods used are the adjusted balance and the average daily balance.
- How adjusted balance is calculated: Total balance – Previous month’s balance. The interest is then charged on the remainder.
- How average balance is calculated: Total of each month’s daily balance divided by the number of days in that specific month.
The method to calculate the balance for purchases on your credit card is displayed on your statement. If you make a late payment or miss payment entirely, you could also be charged a penalty APR which has its regulations depending on the credit issuer. Depending on the nature of the transaction, the interest rates are then calculated and charged on your credit card account. These finally appear on your monthly statement.