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How APR (interest) works - Why it's important

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Page Summary:
The interest charged on Credit Cards is never that easy to understand. APR is the main interest rate and this helps to compare the initial costs between 2 or more cards. However, how the actual interest is calculated is of equal importance. This page explains more.
The interest rate Credit Cards charge is called the APR or Annual Percentage Rate. APR is an important measurement because it not only takes the interest rate into account but also -
  • When it's charged
  • Any fees and other related costs

Without an official APR figure it would be hard to compare the true cost of borrowing on two or more credit cards.

This means a card with a lower interest rate (not using APR) could be more expensive to borrow money on than a card with a higher interest rate. The reason would be the lower rate card has hidden fees and charges attached which wouldn't be reflected by the interest rate.

See Secret 2 - Do your own research - it won't take long - which is one of this site's 10 Secrets to Good Personal Finance

If you can go for the lowest APR rate possible
It's only common sense to apply for a card with a competitive interest rate but whether you qualify will almost certainly be down to your credit rating. If this is good then you have an excellent choice as most providers will be only too happy to do business with you.

But if your credit rating is suspect then your options will probably be limited.

One card which is designed for people with low credit ratings is the Vanquis Card, see below. Yes it's got a high interest rate of around 40% and yes it can have a low limit of between £150 and £1,000. But if you only use it for purchases and do not borrow money on it, it's a good card for someone with limited financial options.

  • It's Visa branded so is accepted across the world
  • Simple online application process
  • More information

More information on the Vanquis Credit Card

Although it's normally very easy for people to qualify there are a few restrictions -

  • You haven't applied for a Vanquis card in the last 6 months
  • You're able to verify your address (e.g. bank statements, utility bills, landline)
  • You're not in the midst of declaring bankruptcy
  • You're registered on the electoral role - See how do I get on the electoral roll
  • You're 18+
  • Representative 39.9% APR variable

If you fulfill the above then you should have no problems in qualifying for the card.

Unfortunately Credit Card APR is not perfect
APR is a good start to compare the cost of borrowing with 2 or more cards. However, to find the true cost you have to look at how a card actually calculates the interest. There are 3 different methods of doing this, some of them better than the others.
1. Adjusted Balance
  • Your balance is taken from your previous statement, new charges for purchases are added and payments are subtracted
  • The resulting figure is then multiplied by the monthly interest rate
2 - Average Daily Balance
  • The most common calculation method used
  • You card tracks your balance day by day and adds charges (purchases) and subtracts payments as they occur
  • To work out the borrowing costs the average of the daily totals is multiplied by the card's monthly interest rate
3. Previous Balance
  • This considers the amount that you owed at the end of the previous billing period
  • Payments and new purchases during the current billing period are not included
  • This means that you can still be charged interest on a debit balance even after you've paid it off
  • The previous balance method is a classic example of just how devious some finance firms can be
Which interest calculation is best
  • Adjusted balance - This method is best if you're borrowing money
  • Average daily balance - This strikes a fair balance between the card holder's interests and those of the card companies but it's not as superior as the Adjusted Balance calculation
  • Previous Balance - If you have a card that uses this calculation and you regularly borrow money then my advice is simple - switch to a card that uses the Adjusted Balance method
How to find out which method of interest rate calculation your card uses
To find out which one a credit card company uses either check your Terms & Conditions or ask to speak to customer support.

See also

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How to Audit your Credit File

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How a clean credit rating can save you money
4 steps to a clean up any mistakes
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