APR, or an annual percentage rate is, basically, the interest that you pay for borrowing money. You can find your APR in credit card terms. Usually APR is the greater the worse your credit history is. For example, for bad credit APRs tend to be around 25%, but for good or excellent credit they can come down to 12%.
The APR formula is calculated the following way. However misleading it may seem, APR is not calculated on an annual basis. In fact, the interest to your card is charged every day. This is called daily periodic rate (DPR) . To calculate it, you need to divide your APR by 365. Say, your APR is 15%. Therefore, your DPR is:
15 / 365= 0,04%
This is going to be added to your balance at the end of the month. However, your balance isn’t also stable. You may charge or pay back sums during the month. That’s why that interest is charged to your average daily balance.
How does the card issuer calculate that? They multiply each balance by the number of days you carried it, then combine them and divide by the number of days in the month.
Let’s say you didn’t make any purchases during the month, nor did you make any payments, and you carried a balance of $1000 to the next month. In that case your average daily balance is:
$1000 * 30 / 30 = $1000
The interest charged this month is $1000 * 0,0004 * 30 days = $12
Not surprising, right?
But let’s change the parameters. During the first 10 days you didn’t do anything, then you charged additional $300, didn’t do anything for 10 days more and then made a payment of $800.
This makes your balance history the following:
Days 1-10: $1000
Days 10-20: $1300
Days 21-30: $500
Your average daily balance is: ($1000 * 10 days) + ($1300 * 10 days) + ($500 * 10 days) / 30 = (10,000 + 13,000 + 5,000) / 30 = 29000 / 30 = $933,33
Your monthly interest will be the following:
$933 * 0,0004 * 30 days = $11,19
And the total sum will be $933 + $11 = $944
Your interest decreased because you paid a large sum ($800) at the end of the month, which not only canceled your additional charges, but lessened your balance.
If you charge more during the month and don’t pay anything back, your interest will increase.
Basically the key to sustaining a good balance is not charging more than you can pay at the end of the month.
This way you can build your credit history, carrying a balance, on the other hand, can hurt your credit history.
However, sometimes you need to use your credit card to make big purchases like a PC or paying medical bills. In that case you can use credit cards with no intro APR (intro period can last up to 15 months) and pay off your balance in full during the intro period with no interest added.
