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!