What it means
Credit cards let you pay later, and the purchase rate is the price of that delay. If you pay the full balance by the due date, most cards charge no interest on purchases, but if you leave part unpaid you are charged interest on the remainder.
Card companies usually quote the rate per year, but it works out month by month. A card with an annual rate of 18% charges interest of 1.5% per month on the outstanding balance, which is why the debt can build up quickly.
Because interest is added to the balance, it compounds. Next month's interest is charged on the original balance plus the earlier interest, so the effective cost over a year is higher than the simple annual figure.
The rate can be fixed for a time or variable. A fixed rate stays the same unless the provider gives notice of a change, while a variable rate moves with market interest rates or at the provider's discretion.
Many cards offer a promotional purchase rate, such as 0% for several months. This can be valuable for a large expense, but the standard rate applies to any balance left after the offer ends, so the plan to repay needs to be clear from the start.
The nuance is the difference from the APR. The purchase rate is the charge for interest on purchases, while the APR is an annual measure that can also reflect compounding and certain fees, so the two figures can differ slightly.
In practice
Real-world examples.
Example
A marketing manager puts a $1,200 conference fee on her corporate card and does not pay by the due date. With a monthly purchase rate of 1.5% she is charged $18 in interest, and the company's accounts receive a note explaining the extra charge.
Example
A student buys a laptop on a card with a 0% purchase rate for nine months. He sets up a monthly payment equal to one ninth of the price so that the balance is cleared before the promotional period ends.
Example
A small business owner compares two cards for office spending. One has a purchase rate of 1.2% a month and the other 1.8% a month, so he calculates that carrying a $5,000 balance for a year would cost roughly $360 more on the second card.
Formula
Calculation
Monthly interest = outstanding balance x monthly purchase rate
Effective annual rate = (1 + monthly rate)^12 - 1
Suppose a card has a monthly purchase rate of 1.5%, which is an annual rate of 1.5% x 12 = 18%. A cardholder carries a balance of $1,200 for a month. Interest = 1,200 x 0.015 = $18. The effective annual rate = (1.015)^12 - 1 = 1.1956 - 1 = 0.1956, or about 19.56%. So the real cost of carrying the balance for a full year is about 1.56 percentage points higher than the headline 18%.Case study
Seen in the real world.
Clover Home Interiors is an illustrative, fictional shop whose manager used a store card to restock cushions and rugs before a busy season. The card carried a monthly purchase rate of 2.0%, and the manager paid it down slowly as sales came in.
The owner's accountant noticed that interest charges of $840 had been recorded in two months. He showed that the same stock could have been funded with an overdraft costing about a third as much.
The shop switched to paying suppliers from its bank account, kept the store card for small items, and made a rule to clear the balance every month. The illustrative lesson is that the purchase rate is only cheap if the balance is paid off before interest starts.
Watch out
Common mistakes.
- Comparing the monthly rate with an annual rate as if they were the same, when 1.5% a month is roughly 18% a year or more once compounding is included.
- Assuming a 0% purchase offer lasts forever, when the standard rate normally applies to the remaining balance after the offer ends.
- Paying only the minimum and expecting the balance to fall quickly, when most of a small payment may go on interest.
Questions
People also ask.
Is the purchase rate the same as the APR?
Not exactly, because the purchase rate is the interest rate on purchases, whereas the APR is a standard annual measure of the cost of credit that may also reflect fees.
Do I pay the purchase rate if I clear my balance every month?
Usually not, because most cards have an interest-free period on purchases when the previous statement balance is paid in full.
Can the provider change my purchase rate?
Providers can change variable rates, and they normally have to give notice before raising the rate on an existing agreement, though the rules depend on the country.
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