APR – The Devil is in The Details!

How credit card companies make money?

Many of us Millennials grew up in the golden age of acronyms like OMG (Oh My God), ‘LOL’ (Laugh Out Loud) and recently, ‘FOMO’ (Fear Of Missing Out). But, there’s one acronym that has even the savviest saying; ‘WTF’, and that’s APR. That’s why we’ve put together a quick guide to help you understand credit card APRs!

What is APR? APR stands for Annual Percentage Rate which, while similar to interest rate, also has a few key differences. For more info on interest rates, check out our last blog post. The APR is the “real” annual cost of borrowing money, including not just interest but also fees and other charges. 

We believe in making things easy for you, so join us as we dive deep into what APR is…and then maybe Yofii can be your bae?

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What is APR? and how is it different from Interest Rates?

The APR or Annual Percentage Rate represents the yearly cost of borrowing money through your credit card across one year. The APR can represent the interest rate charged across a year, or in many instances, it can also account for transaction fees and penalties. APR does not consider compound interest, as compound interest is individually calculated based on a user’s performance and balance(s). The APR is useful for comparing different financial products. Different credit cards have varying interest rates, transaction fees, and penalties. 

If you’re thinking, APR sounds like it’s mostly just an interest rate, why complicate it by introducing a new term? We agree with you. There are very specific differences between the interest rate and annual percentage rates (APR). The interest rate is the amount a lender charges for the use of money or assets expressed typically as an annual percentage. Interest rates can be used in two ways: 1.) to measure the gains or losses investors or savers experience when holding their money in an account or investment; 2.) to measure the amount of money owed to banks or lenders for maintaining a line of credit.

The APR (Annual Percentage Rate), represents the interest rate and other charges resulting from carrying a balance on a credit card or other loan products. As a result of the difference between both rates, the APR will always be higher than the interest rate. 

What are the types of APR?

Traditionally, there are two types of APRs:  

  • Variable APRis found on credit card/loan products where the interest rate charged varies as the market interest rates change. The interest rates change in sync with a specified index (point of reference). The interest rates on Variable APR products can change monthly, quarterly, annually or at any other time. For reference: most credit cards have Variable APR rates.  
  • Fixed APRis found on credit card/loan products where the interest rate charged is fixed and does not change. You can typically find a Fixed APR on mortgages, automotive loans, or personal loans. In the event a bank, lender, or creditor wants to change their APR, the terms of the loan specify the responsibility of the bank/lender/creditor’s for communicating any changes. 
Yofii Tip: If you are considering purchasing a home or getting a personal loan, WE DO NOT RECOMMEND VARIABLE APR OR INTEREST RATES. Whenever you are starting a new loan product we always recommend products with Fixed APRs as they are less expensive long-term and provide you consistency with your budgeting, ESPECIALLY FOR MORTGAGES!

How to Apply the Annual Percentage Rate

Step 1: Calculate Your Daily Periodic Rate

For example: If your APR is 15.0%, you should be dividing 15.0% by 365 days (number of days in a year), which will give you a daily periodic rate of .041%.  

In some situations, creditors will use 360 days instead of 365 days, so make sure you review your credit card/loan product’s terms and conditions to know which number to use. The terms and conditions for your credit card may show different rates for different use cases. You may notice a higher APR for cash advances than standard purchases. Ensure you are running using the correct APR in your calculations. 

Step 2: Apply Your Periodic Rate For The Month

Now that you have your daily period rate, let’s put it to good use! Multiply your daily periodic rate by the number of days in the month you are calculating your interest for. For example, January has 31 days. In January you would multiply your daily periodic rate by 31. Following the above example, you multiply your daily period rate of .041% by 31 and your result is 1.27%. For the month of January, your true interest rate is 1.27%. The creditor will add these charges to the billing cycle due the following month, for example, February 15th. Your next step is to calculate your average daily balance. 

Step 3: Calculate Your Average Monthly Balance

Your balance changes daily, weekly, and monthly. The challenge with calculating your average monthly balance is your card balance. Your card balance changes all the time as it follows your spending activity. Your interest is applied to your average monthly balance as your balance fluctuates so often. For example, you owed $100 for the first 21 days of the month and owed $200 for the remaining 10 days, your average balance will be approximately $150. The interest applied to your balance will be based on this number. 

Now let’s put this into practice!

Let’s say your Annual Percentage Rate is 20% and you do not use your card that month, so your balance remains unchanged. You calculate your daily periodic rate as mentioned in Step 1 and you divide 20% by 365 to be given a result of 0.05479. If you’re calculating your interest for the month of January which has 31 days, you will multiply 0.05479 by 31 and receive a monthly interest rate for the month of January of 1.69849%. In the event your Average Monthly Balance is $100, you will multiple your Average Daily Balance ($100) by your Monthly Interest Rate for January (1.69849%) for a result of $1.70 in interest. If the third number after the decimal is 5 or greater, we always round up! 

Math: ((.20 / 365) x 31 days) x $100 = $1.70 dollars in interest 

The Truth About Credit Cards:

Credit cards are a business, and creditors make money in a number of ways. The most obvious way of making money is by charging users interest payment. The interest you pay overtime allows the credit card companies to fund their operations. Your interest allows credit card companies to grow their business to offer you new products and services. Aside from interest, transaction fees are another source of income for credit card companies. These transaction fees are charged to the merchant for processing every transaction a customer makes with their credit card. Credit card companies have many ways of making money both with and without your monthly interest payments.

The Yofii Team Does Not Hate Credit Cards!

We believe credit cards are a delicate tool which can help you accomplish amazing things. Credit cards can also stress you out if you mismanage them. We’re designing Yofii to help you simplify your financial situation. Yofii will help you get out of any messy situation you may have gotten yourself into. Yofii is designed to help you improve your financial situation long-term. We believe people should have the freedom to spend the money in the ways they want and not work to JUST PAY BILLS! Subscribe now to stay up to date on the great content we’ll be putting out and on the launch of our application!

Want to know more about credit cards? Don’t forget to check out our last blog: Credit Cards: Friend or Foe? How do Credit Cards REALLY work?

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