The world of credit cards can be confusing, whether you’re new to it or not.
One question we get pretty frequently is: What is the difference between the interest rate and the annual percentage rate? Are credit card APRs and interest rates the same thing?
Keep reading to find out.
What’s the difference between interest rate and APR?
With some financial products, the interest rate and the APR are different. With credit cards, though, they’re basically the same.
The U.S. Government’s Truth in Lending Act requires all consumer lenders to state their interest rates as APRs. APR is considered the “real” annual cost of borrowing money, including fees and other charges in addition to the interest rate.
If you take out a mortgage, for example, you’ll pay an origination fee and other charges upfront; these then get factored into the APR on your mortgage. So, a mortgage with an interest rate of, say, 5.5% might actually cost you something like 5.8% a year. Credit cards don’t do that, meaning the APR on your card is precisely equal to your interest rate.
Is APR the same as the interest rate?
Yes, the APR is essentially the same as the interest rate for credit cards. However, the APR may be higher than the interest rate for other interest-accruing products like mortgages and car loans. That is because there are often fees and charges incorporated into the APR on these products.
Related: What is a good APR for a credit card?
Does the Federal Reserve’s interest rate affect credit card APR?
Yes, since most credit card APRs are variable and are adjusted based on market conditions.
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In short, the Federal Reserve sets interest rates — known as the federal funds rate — that banks use to lend money to one another (or to borrow directly from the Federal Reserve). Then, there’s the prime rate, which is generally 3 percentage points higher than the federal funds rate. Banks use this as a starting point when they lend to consumers, and it tends to change in line with the fed funds rate.
From there, banks add additional markups based on the type of loan (home equity, car, mortgage, credit card, etc.) and the borrower’s creditworthiness. Since credit cards require the least underwriting and have the largest capacity for overspending — you can’t just take a car loan and purchase a bunch of electronics or a pricey vacation — they typically have the highest risk and thus the biggest markup.
As a result, your current credit card’s APR is essentially the current prime rate plus a markup set by your bank. As the federal fund rate (and thus the prime rate) decreases, your APR decreases as well.
Bottom line
The APR and interest rate on credit cards are the same. Annual fees or charges on things like balance transfers, cash advances and late payments are not included in the APR because credit card companies can’t predict which cardholders will incur which fees.
Of course, you can avoid paying credit card APR altogether by paying your balance on time and in full, one of TPG’s ten commandments of credit card rewards.
If you’re working on paying down your debt, a 0% APR card can help reduce your borrowing costs.
For more information, check out TPG’s list of the best zero-interest cards.
