Dubai: When it comes to interest rate charges that are incurred with your loans or debt, you may have seen the term APR, or annual percentage rate, used in reference to everything from home and vehicle loans to credit cards.
Here we look at credit card APR, which you’ve seen listed on your monthly statements. Knowing what an APR is, how it’s calculated and how it’s applied can help you with your credit card decisions.
Credit card interest is calculated using the APR, which is the interest rate, expressed as a yearly (hence annual) rate of interest. In other words, APR is an annualised representation of your interest rate.
When deciding between credit cards, APR can help you compare how expensive a transaction will be on each one.
The lower the APR number, the better it is for you. You get to pay less for the privilege of buying things with a credit card. The number will vary not only from card to card but also from person to person – the APR can be determined on factors such as credit score.
In order to make sense of your own APR then it may be easier to convert your annual rate to a daily percentage rate (DPR) or what is referred to as the periodic interest rate.
To find out your daily rate, divide your APR by 365 – some UAE banks may use 360. For example, if your credit card has an APR of 30 per cent, divided by 365 it’s 0.082 per cent a-day – although that doesn’t seem like much, keep in mind that it adds up to much more.
Knowing how much you owe
Once you know what your APR and DPR is, then you need to figure out how much you owe using your average daily balance. This is because your credit card balance can fluctuate from month to month as you make different payments each time.
So, let’s say at the beginning of the month you still owe the bank Dh1,000 and let’s say 20 days into the month you decide to buy a new phone costing you Dh2,000. That means at the end of the billing period you owe the bank at least Dh3,000 – that’s excluding other small payments you may have made on your card throughout the month.
Now calculate the amount of interest you will owe for the month. So, you take your average daily balance x your daily percentage rate x your billing cycle (1,333 x 0.082% x 30), and your interest from the month will be Dh32.79. Again, that may not seem like a lot but if you spend roughly the same each month then at the end of the year you will be paying around Dh400 in interest.
Is it avoidable?
You don’t have to pay any extra interest on your credit card bill. You can easily avoid it if you pay your balance in full each month. If you pay off the full amount rather than paying the minimum amount you will most likely only be covering the interest accrued.
You can also avoid high interest rates if you chose a credit card with low APR. Credit cards that offer benefits usually carry a higher APR. There are different types of card you can use from in the UAE, like standard, gold or platinum.
If you have a standard credit card, you are likely paying less interest fees than the rates that come with a platinum credit card. But if you have good credit history then some banks in the UAE could offer you extended interest free periods.
Now let’s consider two main things about how APR works: how it’s applied and how it’s calculated.
The quoted APR interest rate is applied to the reducing balance of the loan over the repayment period. As a result, you pay interest only on your remaining balance, which will have significantly reduced in the final period of the loan repayment.
Let’s illustrate with another example!
Assume that you have an amount outstanding on your credit card of Dh10,000 and let’s assume the monthly interest rate on the credit card is 3.25 per cent.
We first find the APR by multiplying the monthly interest rate by 12. This gives us an APR of 39 per cent, which is the annualized interest rate for the card.
Next, we arrive at the daily rate of interest by dividing the APR by 365, hence we get a daily interest rate of 0.1068 per cent (39 per cent, divided by 365 days).
The interest charge for the day is calculated by multiplying the outstanding balance as of that day (which we have assumed to be Dh10,000) and the daily interest rate (which we have calculated to be 0.1068 per cent). Thus, we arrive at an interest charge of Dh10.68 (10,000 multiplied by 0.1068 per cent).
This interest charge of Dh10.68 is then added to the outstanding balance amount due, so the new outstanding balance on the credit card becomes Dh10,010.68.
If no additional purchases or payments are made ..
If there have been no purchases or payments made on the same day, then the opening outstanding balance on the next day will be this figure of Dh10,010.68.
The interest charge for the next day will be calculated using this new outstanding balance amount. Hence, in our example the interest charge for the next day will be 10,010.68 multiplied by 0.1068 per cent, which is Dh10.69, making the new outstanding balance amount Dh10,021.38.
In this example, simply continuing this calculation and assuming no payments or additional purchases are made, the outstanding balance increases to Dh10,150.63 which represents interest charges of Dh150.63 in just 15 days.
What is also critical to note is that this amount does not increase uniformly over each day but is in fact compounding because interest for each day is also calculated on interest that was charged for every day prior to that.
In the above example, after 30 days the outstanding balance increases to Dh10,314.54. The total interest charges in the first 15 days was Dh150.63 but the interest charges over the next 15 days totaled to Dh163.91. This figure would only keep rising with time unless payments are made to reduce the outstanding balance.
Introductory APR or Promotional APR: Features a lower APR for limited time period. It can apply to specific transactions as well as balance transfers, cash advances or any combination.
Purchase APR: The rate applied to credit card purchases.
Cash advance APR: The cost of borrowing cash from your credit card tends to be higher. There may be a different APR for cheques or certain types of cash advances, and keep in mind there is no grace periods.
Penalty APR: Usually the highest APR. It may also be applied to certain balances when you violate the card terms and conditions like failing to make payments on time.
Generally, lenders cannot change the APR for the first 12 months. However, an APR can change in that period if it’s a promotional or variable rate or if the terms and conditions are violated. In most circumstances, when changing terms and conditions, companies give 45 days advance notice.