Glossary: Annual Percentage Rate (actually charged daily)

8 Jan
Throughout this blog, there will be posts that define important terms to know when understanding credit cards. These posts and definitions will be summarized on my glossary page.
 

In theory, the Annual Percentage Rate (APR) is the interest rate charged annually on the outstanding balance of a credit card. For instance, if a particular credit card had an APR of 15%, and there was a $100 outstanding balance on that account for a year, the interest charged would be $15. However, when applied in actuality, it’s not so simply.

See, nearly all credit cards charge interest DAILY based on the DAILY outstanding balance using a Daily Periodic Rate (DPR). This is found by taking the card’s APR and dividing it by 365 days per year, generally round to the nearest 1/100,000th of 1%. So, going back to our example of 15% APR, the DPR would be 15% ÷ 365 = 0.041009589, rounded to the nearest 1/100,000th is 0.04101 interest charged on the daily balance. This may not sound like much, but with the effect of compounding interest added DAILY, it grows to be a big number quickly.

What’s compounding interest? Stay tuned for a future post that defines and illustrates the astonishing effect of compounding interest.

So, at the end of the day, the APR is actually just used to find and calculate the DPR, and actual interest charged on a credit card balance can end up being way more than the stated APR. Buyer (a.k.a. credit card holder) beware!

APR graphic relating to DPR

A graphic found on Bank of America’s website that simplifies how the APR relates to the DPR.

Advertisements

One Response to “Glossary: Annual Percentage Rate (actually charged daily)”

Trackbacks/Pingbacks

  1. BofA boasts cash rewards of 3%, yet they cash in at 18.99% | limited-time rate - January 11, 2014

    […] rate of 18.99% for that same 90-day period, you’d pay $48 in interest, accounting for the daily periodic rate and compounding interest. When the average credit card debt for a credit card holder in the U.S. is $5,047, it’s not […]

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: