Credit Cards 101: Understanding APRs and Potential Risk
Nowadays, new credit cards are popping up left and right. Paypal, Venmo, Apple, and more all have their own credit cards now, which come with different fine prints and APRs. Navigating these different options can be confusing, and some common questions we receive are:
- How do you know which provider to trust?
- How do you know if you should even open a credit card?
- Are credit cards safe?
- How do APRs work?
- How many credit cards do I need to build credit?
All of these questions are valid, but the answers can be confusing when looking at a credit card’s fine print. Let’s dig deeper into the ins and outs of credit cards.
First, what is credit card APR?
Right off the bat, let’s cover some important basics. APR stands for annual percentage rate, which is the interest on some type of credit account. With a credit card, APR generally refers to the interest applied to your account during a given billing cycle.
It most often comes into play if you carry a balance, but APR can also apply to interest on charges or transactions including:
- Late payments (penalty APR)
- Cash advances
- Balance transfers
And FYI, APR and interest rate are not the same thing.
Interest rate refers to the annual cost of a loan to a borrower and is expressed as a percentage
APR is the annual cost of a loan to a borrower — including fees. Like an interest rate, the APR is expressed as a percentage. Unlike an interest rate, however, it includes other charges or fees such as mortgage insurance, most closing costs, discount points and loan origination fees.
So, how do you calculate a credit card’s APR?
Credit card APR is calculated with the following formula:
Daily rate X average daily balance X days in billing cycle = credit card interest
To explain this further, there are 365 days in a year, and if your APR is 19%, your daily rate is 0.00052. The average daily balance is taking the average of the balance you held at the end of each day in the month. As for the number of days in the billing cycle, it’s exactly what it sounds like.
If you pay off your credit card balance for each pay period, you won’t have to worry about APR. However, if you don’t, you may potentially waste hundreds of dollars in interest fees alone as the average daily balance has then increased. Does that make sense?
Financially speaking, this can become a problem…
How much could APRs really cost me?
For perspective, the average American’s credit card debt in 2021 is $5,315 and the average American’s credit card limit is $30,365. Let’s look at three different scenarios (all using rough estimates) with a 19% APR in a 30-day month to see the costs:
- Scenario 1: Sally pays off her credit card each month
- Result: No additional interest charges accrued
- Scenario 2: Sally has on average $5,315 in credit card debt after paying off some of her debt throughout the month
- Result: 0.00052 x $5,315 x 30 = $82.91 in additional interest charges for one month
- Scenario 3: Sally has on average $30,365 in credit card debt after paying off some of her debt throughout the month
- Result: 0.00052 x $30,365 x 30 = $473.69 in additional interest charges for one month
While these are just estimates, if this cycle continues these interest rate charges may even increase if Sally isn’t able to continue paying down her debt. These interest rate charges happen each month which can add up.
Scenario 3, for example, could add up to almost $6,000 in one year. To check on your own credit card debt repayment, use this Bankrate calculator here.
Why credit cards aren’t always the solution…
While credit cards can absolutely be helpful in building credit, they can also hurt your credit score. When you have consistent interest payments and increasing credit card debt, your credit score may not respond well.
Yes, credit cards can help in a pinch when you need cash for something, but it can also open Pandora’s Box to endless spending, especially as a person’s credit limit increases. If you are looking for extra cash and don’t want to hurt your credit score, ask your employer about TrueConnect.
TrueConnect is an employer-sponsored loan program that allows no credit check to apply. Funds are available within one business day and loan repayment is through automated payroll deductions over one year.
You may increase your credit score as all repayments are reported to all three credit bureaus. All borrowers have an APR of 19.99% which compares to credit cards and actually helps you rebuild your credit and financial standing.
If you’re interested in bringing TrueConnect to your organization, share this on demand demo with your benefits director.
TrueConnect™ is a trademark owned by Employee Loan Solutions, LLC. Through benefit arrangements between Employee Loan Solutions, LLC and employers, loans and other financial services are offered by various lenders to employees.