Guest article from BadCredit.org
Whether you blame text messaging, millennials, or simply busier lives, our modern society has developed a dependence on acronyms that can make it difficult to communicate unless you’re firmly in the know. At the same time, some of these acronyms have been around long enough that we really ought to know them — especially those that directly impact our finances.
One of the most important acronyms in the consumer credit world (and the business credit world, at that) is APR, which is short for annual percentage rate. In essence, APR refers to the interest rate you pay for a particular credit product — be it a loan, a credit card, or some other type of credit line.
For the most part, the details and specific applications of an APR, including the relationship between the APR and the actual interest you pay, will vary by the type of credit product. For example, the ins and outs of your credit card APR will be different than those for a loan APR in several key areas.
Your Card Likely Has Multiple APRs
The fact that a single credit card may have multiple APRs can be a source of much confusion for the credit card novice, but it’s pretty straightforward once you know what to look for — and where to look for it.
In general, your average credit card will have as many as three different transactional APRs, with the exact APR you’re charged dependent upon the type of transaction responsible for that portion of the balance. The typical transactions with their own APR include new purchases, cash advances, and balance transfers.
As an example, consider a hypothetical shopper, Shonda, whose total $850 credit card balance includes: $500 in new purchases, $100 in cash advances, and $250 from a transferred balance. If Shonda’s credit card charges 15% APR for new purchases, 20% APR on cash advances, and 10% APR for balance transfers, then she’ll be charged three separate APRs on her balance: 15% on the $500 in new purchases, 20% on the $100 in cash advances, and 10% on the $250 transferred balance.
Aside from promotional balance transfer APRs, most credit cards will have the same rate for both balance transfers and new purchases, but don’t let this fool you into thinking the two transactions will be treated the same way. Specifically, the interest fee grace period that applies to new credit card purchases doesn’t apply to other transaction types, meaning you’ll likely be charged interest on balances from balance transfers and cash advances as soon as the transaction is complete.
The details of your card’s APRs can be found in your cardholder agreement, which was part of your welcome kit and can also be downloaded from your issuer’s website. If your cardholder agreement doesn’t specify an APR for a certain transaction type, chances are good that the card doesn’t support that type of transaction. For instance, store cards and other easy credit cards to get for rebuilding credit may not allow balance transfers to the card.
Late Payments Can Increase Your APR
Another hugely important APR fact to remember is that making late credit card payments can actually increase your APR. Specifically, many credit cards will instigate a penalty APR if you make a late payment, and that penalty can be huge — 30%-APR-or-higher huge.
Penalty rates aren’t strictly limited to issuers providing credit cards for bad credit, either; even prime credit cards may charge you a penalty APR after missing a payment. This can be particularly painful for cardholders who are enjoying a 0% APR from an introductory offer, as you could go from zero to 30% in the blink of an eye.
Even worse, penalty APRs won’t apply solely to the balance you had when you made the late payment. Many credit cards will require you to meet certain conditions, such as making six months or more of on-time payments, to return to your normal purchase APR. And some cards will actually charge you the penalty APR indefinitely.
The easiest way to avoid falling victim to a penalty APR is to avoid late payments entirely by automating your credit card payments. This will ensure your bill is always paid by the correct date, regardless of whether you actually remember the date.
Credit Card Interest Rates Are Variable
Something that can be confusing for even seasoned credit card veterans is that the APRs charged by your credit cards are often variable, meaning they can change as the market changes throughout the year. The most common type of variable APR is based on the Wall Street Journal Prime Rate (WSJ Prime Rate), which is a measure of the US Prime Rate determined by the interest rates being charged by the 30 largest US banks.
Despite popular assumption, the Prime Rate isn’t set by a specific government body, though it is heavily influenced by the federal funds rate overseen by the Federal Reserve’s Federal Open Market Committee (FOMC). Historically, the Prime Rate tends to remain three percentage points above the federal funds rate.
Changes in the federal funds rate will occur as deemed necessary based on the current economy, with rates generally decreasing in flagging economies and increasing as the economy improves. There are no limits on how often a rate change can occur. The rate may change multiple times in one year, for instance, or go several years without changing at all.
As the federal funds rate changes, so, too does the WSJ Prime Rate. And since your credit card’s APR most likely is based on the WSJ Prime Rate, changes in the federal funds rate can mean changes in your APR. Each change in the federal funds rate is typically made in quarter-point increments, meaning a single rate change could see your credit card APR increase by 0.25%.
Save a Lot of Cash with a Little APR Knowledge
Whether we like it or not, we live in a fast-paced, acronym-rich society — even in the often-behind-the-times financial industry. As such, it’s up to us to stay informed on the important terms impacting our lives (and pocketbooks).
While hardly the only acronym that will crop up along your personal finance journey, APR is definitely one of the most common in the credit world. It can also be one of the most expensive, especially if you don’t know the important facts, such as the painful truth of penalty APRs.
On the other hand, armed with the right knowledge, you can go forth and do battle against high APRs, excessive interest fees, and dreaded penalty APRs like a financial pro, potentially saving yourself money — and a headache.