APR: The Ins & Outs of Credit Card Interest

Credit card APR (aka Annual Percentage Rate) represents the cost of borrowing on a credit card if you don’t pay the balance in full each month. It includes interest and other charges, providing a complete picture of the cost over a year. 

For example, an APR of 29.99% means that, in theory, you would pay 29.99% of your outstanding balance in interest over the course of a year–assuming the APR remains constant and you make no additional charges or payments.

However, calculating the actual cost of a 29.99% APR over time on an outstanding balance requires knowing how the interest is compounded – that is, how often the interest is calculated and added to the balance. Credit card interest is typically compounded daily, but the issuer could use a different method. 

For instance, let’s assume you have a $1,000 balance on your credit card, and you’re planning to pay it off over two years without making any additional purchases. The daily rate would be the APR divided by 365. If you make equal monthly payments to pay off the balance and the accrued interest over 24 months, the amount you’d pay each month and the total paid over the period can be calculated.

Let’s do the math to show what the monthly payment might look like and the total amount paid over two years.

To pay off a $1,000 balance on your credit card with a 29.99% APR over two years, you would need to make monthly payments of approximately $55.70. Over the two-year period, the total amount paid would be about $1,336.71. This means you would pay around $336.71 in interest on top of the original $1,000 balance. This calculation assumes the APR remains constant, interest is compounded monthly for simplicity, and you make no additional charges to the card during this period.

It’s important to note that compounding interest can quickly increase your debt and put a strain on your monthly budget. It is important to pay more than the minimum every month in order to keep the debt from mounting! 

Understanding APR is critical when it comes to creating and maintaining a budget that you can live in without perpetually being in credit card debt. Knowing the true cost of items that you put on credit cards might help you against impulse purchases and keep you on the path to financial freedom.