What it means
APR stands for annual percentage rate, the yearly cost of borrowing shown as a percentage. The purchase APR is the version that applies to goods and services bought with the card, and it is often the lowest of the several APRs a card carries.
Most cards have a grace period, a window between the statement date and the due date during which no interest is charged on new purchases if the previous balance is paid in full. Once a balance is carried over, the grace period is usually lost and interest is charged from the purchase date.
Interest is normally calculated daily. The issuer divides the APR by 365 (or sometimes 360) to find a daily rate and applies it to the average daily balance, so the longer a balance stays unpaid, the more interest builds up.
Charges added to the balance start earning interest as well, which is why debts on cards can grow faster than people expect. The rate can be fixed or variable.
A variable rate moves with a reference rate such as a central bank rate or a bank's prime rate, so the cost of borrowing on the card can rise or fall without the cardholder doing anything. Businesses need to understand the figure because company cards used for expenses can become an expensive form of financing.
A manager who routinely carries a balance is paying interest at a rate that is normally far higher than a bank loan or an overdraft. The nuance is that a promotional offer may carry a lower or zero purchase APR for an introductory period.
When that period ends the standard rate applies to any remaining balance, so the plan to repay should be set before the deadline.
In practice
Real-world examples.
Example
A consultant buys a $3,000 laptop on a credit card with a 22% purchase APR. She repays $1,000 each month, so interest accrues on the declining balance, and she totals the cost across three statements to see how much the financing added to the price. She finds that the interest comes to roughly $110, which is small but avoidable.
Example
A small bakery uses a card for flour and packaging and pays the full balance every month before the due date. Because of the grace period, the owner pays no interest and effectively receives up to several weeks of free credit. He treats the card as a payment tool rather than as a loan.
Example
A start-up founder moves company expenses to a card offering 0% purchase APR for 12 months. His finance adviser sets a reminder in month 10 to repay the balance, because the standard rate will apply to anything left afterwards. The adviser also warns him not to add new spending that he cannot repay in time.
Formula
Calculation
Daily rate = purchase APR / 365
Interest for the period = average daily balance x daily rate x number of days
Suppose a card has a purchase APR of 24% and an average daily balance of $2,000 over a 30-day billing cycle. The daily rate = 0.24 / 365 = 0.0657534%. Interest = 2,000 x 0.24 x 30 / 365 = 14,400 / 365 = $39.45. If the balance were paid off in full by the due date, the interest on purchases would be $0 because of the grace period.Case study
Seen in the real world.
Orchard Print Studio is an illustrative, fictional design business whose owner paid for paper, ink and a new press with a business credit card. Cash was tight, so she paid only the minimum each month.
When the bookkeeper analysed the card statements, he found that the studio had paid $1,150 in interest over the year on an average balance of about $5,000. That worked out at 23%, in line with the card's purchase APR.
The owner arranged a term loan at a lower rate, used it to clear the card and started paying new purchases in full each month. The studio's interest cost fell by more than half in the following year. The illustrative lesson is that a high purchase APR turns convenient credit into an expensive loan when balances are carried.
Watch out
Common mistakes.
- Believing interest is avoided simply by paying the minimum, when carrying any balance can cancel the grace period and lead to interest on new purchases too.
- Assuming the purchase APR applies to cash advances or balance transfers, when these usually carry separate rates and fees.
- Ignoring that a variable APR can rise, which can make a card more expensive without any change in spending.
Questions
People also ask.
What is the difference between purchase APR and cash advance APR?
Purchase APR applies to goods and services, while the cash advance APR applies to cash withdrawals and is usually higher and starts charging interest immediately. Cash advance fees are usually added on top, so the cost is higher still.
How is interest on purchases calculated?
The issuer applies the daily rate to the average daily balance for each day of the billing cycle and adds up the daily amounts.
Can I avoid paying purchase APR altogether?
Yes, if you pay the full statement balance by the due date each month, most cards charge no interest on purchases. The issuer's terms set out exactly how the grace period works, and they are worth reading carefully.
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