What does "APR" really mean?

By Marianne Curphey

The term "Annual Percentage Rate" is thrown around a lot in discussions about credit cards. Most of us know that a low APR is ideal, but we may not really understand how it's calculated. And knowing in pounds and pence how much our APR costs us is even harder to grasp.

Your APR describes the interest rate on your credit card for a whole year rather than just a monthly rate. It includes any upfront charges by the lender. You are charged interest on purchases made with your credit card until your balance is paid.

Often, when looking into a new credit card, you will see the "typical rate." This number is the rate that a card company might advertise, but not necessarily the rate that you will pay. This is because lenders set the actual interest rate charged according to the borrower's credit record and personal circumstances.interest-rates

Even when your individual APR is clearly spelled out, it won't give you the whole picture. A study by the Personal Finance Research Centre (PFRC) at The University of Bristol outlines some of the shortcomings of APR as an indicator of a card's costs. The research resulted in a website to help consumers better understand credit card costs, hosted by the UK Cards Association.

On the site, you can calculate how much your credit card costs you each month based on how much you owe on the card (or, if you are simply planning to use your card, you can use hypothetical figures), how you pay your balance, what the annual fee is and other factors. Then you can see how long it will take to pay off your balance using various methods.

"Many people don't really understand what APRs mean to them because it does depend on the method you use to repay your credit card balance," says Sarah Treadwell-Jones, of the UK Cards Association.

"For example, if you pay your balance off in full every month then it does not really matter to you what the APR is. What the site shows in nuts and bolts terms is how much time and money you could save by paying off a bit extra. You can do the calculations and change the repayment amounts and see the difference that makes in real terms for your own personal financial situation."

One way to lower your overall credit costs is to consider your personal spending habits and find a card that matches those needs. For instance, if you typically pay off your credit card purchases immediately, a card that offers interest-free days might be a good choice for you. No matter what the interest is on these cards, you will have a grace period before interest starts getting charged on your purchases. As long as you pay before that grace period is up, you won't be charged any interest at all.

If you plan to make a large purchase that you will need several months to pay off, a low-interest credit card or a card that offers no interest for several months is the better choice. If you go with the latter, however, make sure you can pay off your balance before the interest-free period ends, or else you'll likely get hit with a steep rate.

See related: That wasn't the APR I applied for!, Personal loans v credit cards: What's the best way to borrow?

Published: 24 September 2013