One of the most confusing concepts regarding credit of any kind is the difference between APR and interest rate. Most people use these terms interchangeably, but technically they mean different things. So does the difference matter when it comes to your credit card?
Let’s first sort out the technical differences of the terms when it comes to credit in general.
Nominal interest rate
The interest rate is the actual interest you pay on a given credit balance, expressed in percentage terms. This is sometimes referred to as the “nominal interest rate.”
So if you go to the bank and take out a mortgage loan, and you only consider the actual interest you are paying on that mortgage, that’s the nominal interest rate. If you are paying 5% per year on a $100,000, 50-month term loan, you would pay $5,000 in interest.
APR
APR stands for Annual Percentage Rate. The Truth in Lending Act, as well as Regulation Z and a host of individual state laws, requires that all loans be expressed as APR. That’s because APR will also factor in all fees, closing costs and anything else associated with the loan.
Let’s go back to that mortgage. Suppose there were $5,000 in fees on top of that $100,000 mortgage, bringing the total amount you are actually financing to $105,000. Let’s say that $5,000 in fees is spread across the 50-month loan equally. That would mean you would pay an extra $100 per month, for a total of $5,100.
Your APR would be 5.1%.
Why APR?
Regulations require that APR be disclosed to us borrowers so that we can make an apples-to-apples comparison on loans. That way, since different lenders offer different interest rates and fees on loans, we can boil it all down to a single number to see what the best APR is.
Now, let’s look at APR vs. interest rate and see if the difference matters for your credit card.
How it works for credit cards
The same concepts apply, but the names are different. “Nominal interest rate” in the world of credit cards is called “nominal APR.” “APR” is referred to as “effective APR,” and, like other loans, it includes fees.
However, when it comes to credit cards, there generally are few or no fees. In fact, if your credit card is charging you fees other than an annual fee for having the card, you probably have a lousy deal.
Fees?
The only other fees generally seen are late fees or over-the-limit fees. These may not even show up as effective APR rates. They may simply get tacked on to whatever minimum payment you have that month. Some cards may fold these fees into your nominal APR, which will create a very slightly higher effective APR.
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