How do interest rates and APR work on credit cards?

Interest rates and annual percentage rate (APR) are critical aspects of credit card usage, as they determine the cost of borrowing money on your card. Here's how they work:

  • Interest rate: The interest rate is the cost of borrowing money expressed as a percentage of the principal balance. Credit card issuers usually charge interest on purchases, cash advances, and balance transfers. Rates can be fixed (remain the same) or variable (change based on an underlying index, such as the prime rate).

  • Annual Percentage Rate (APR): The APR represents the annualized cost of borrowing, including interest and any other fees or charges associated with the credit card. Credit card issuers often have different APRs for purchases, cash advances, and balance transfers. Your APR may also vary depending on your creditworthiness, with better credit scores generally qualifying for lower APRs.

  • Grace period: Most credit cards offer a grace period, typically 21-25 days, during which you won't be charged interest on new purchases if you pay your balance in full by the due date. This interest-free period allows you to borrow money without incurring interest charges, as long as you pay your statement balance on time.

  • Compounding interest: If you carry a balance on your credit card, the interest is usually compounded daily or monthly. This means that interest is added to the principal balance, and future interest is calculated based on the new, higher balance. This compounding effect can increase the cost of carrying a balance on your credit card.

  • Minimum payments: Credit card issuers require cardholders to make minimum monthly payments, usually a percentage of the outstanding balance or a fixed amount (whichever is higher). While making the minimum payment can prevent late fees and negative credit reporting, it can also result in higher interest charges over time, as the remaining balance continues to accrue interest.

Understanding how interest rates and APR work on credit cards can help you manage your credit card usage more effectively, minimize interest charges, and maintain a healthy credit score.

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