Wednesday, November 7, 2012

Credit Cards: There are two different interest rates

One of the very simple but so important factors in any loan is the interest rate. Depending on how you calculate
an interest rate, the amount that you pay in interest changes dramatically.

There are two different interest rates:

Annual Percentage Yield – Annual percentage yield is the rate that the bank or credit card company uses as its nominal rate. The APY is the rate that will be divided into periods and then compounded. A credit card at 18% APY would be divided into 12 for monthly interest of 1.5%. Then, that rate would be compounded monthly, resulting in APR.

Annual Percentage Rate – The annual percentage rate is the annual percentage yield after compounding. Hence, a 1.5% rate per month when compounded is equal to 19.56% APR. The APR is the actual amount of interest that you will pay. You might hear the APR used as EAR, or effective annual rate. The effective annual rate is the same as the APR.

When you shop for a new credit card, always look at the credit card rate (APR) as it is the actual rate of  interest that you will pay. The APY is always lower, less expensive, and often it is more commonly advertised than APR. Always do your research by looking at the all the small print that accompanies a credit card offer. You should always be able to find the APR – the true cost of the credit card interest – on the back of a credit card offer.