How do APR, interest rates, and billing cycles work?


For context, I’m 21 years old and I’ve never had a credit card, and I never learned about them. I don’t know anything about them. Now I don’t understand anything I’m reading on these credit card sites, and I don’t know what to look for to avoid getting the worst card possible. I know I won’t be getting great interest rates, but other than that I’m entirely clueless. What even *is* APR, and how is it calculated? How long is a billing cycle? Does it vary by card? if I have NO credit history, what’s the best interest rate range I can hope for? What kinds of cards can I even apply for with no credit history?

In: Economics

You borrow money from the bank. That’s credit. They expect you to pay it back with a ‘fee’ which is interest. APR is the annual rate of interest. If you borrow $100 for a year at $10 APR then you pay back $110.

It’s not quite as simple as this in general because, with credit cards, interest stacks differently for purchases, cashback and balance transfers. So you might see a different rate for these items.

APR depends on risk. If you are risky to lend money to (you’ve been bankrupt) or banks don’t know how risky you are (no credit history), you get a worse rate. Rates depend on your risk, your country’s risk, the bank’s risk appetite, etc.

Billing cycle is the period of time when they charge you. So you might get a bill at the end of June for everything you spent between the 7th of May to the 7th of June, which is the billing period. The cycle might be every 30 days, for example.

APR- annual profit rate, generally the yearly interest plus any fixed fees

Interest is exactly that, just interest on the borrowed amount. Do note that it may be monthly or set to some other non- annual period. So 3% monthly interest costs you 3c on the dollar a month, or about 36c a year, roughly similar to 36% annual interest

You billing cycle is when your credit card bill gets made, and distinct from the payment date. If your cycle date is the 5th and payment date is the 25th, whatever you spend between May 5 and June 5 is due for payment on June 25.

Do note that most credit cards have a high monthly interest rate(often around 3%) and a low minimum payment amount(generally around 5%), so if you pay the min amount, you aren’t reducing the amount you owe by much since most of it goes towards interest. Also if you miss your payment date you get hit with fees etc, so always have a reminder set for that. However if you’re careful and don’t bite off more than you can chew you’ll be alright, just be sure to always read the fine print and ask questions.

When you have a credit card, you will get a monthly statement with a due by date usually about 3 weeks out. If you pay your balance in full before that date, you pay no interest on the purchases. So if you spend $500 during the month, pay that full $500 you effectively get a 3-7 week loan for free.

If you carry a balance, paying off less than the full balance due, you will accrue interest on the amount carried over and any new purchases. The APR is the annual percent rate, which is similar to the interest rate, but factors in that you’ll be paying interest on the amount the earlier interest causes your balance to go up.

Pretty much all credit cards have high interest rates of 15-25% APR, so you really don’t want to carry balances and pay that much interest on your purchases.

As others have mentioned, APR stands for Annual Percentage Rate, but bear in mind that it’s an annual rate, and you won’t be borrowing money on a credit card for a whole year.

Let me explain (and in this example I’m going to keep it simple by saying the billing cycle is a calendar month, and the APR is 10%): In January you get a credit card and spend $100 on it. You spend an additional $75 on the card in February. You get a bill at the end of February that says you have to pay a minimum of 5% of the outstanding balance for the January billing cycle, which is $100. You don’t have $100 so only pay off $50, which is fine, because that’s more than the minimum payment. In March you spend $120 on the card. At the end of March, you get a bill for the February billing cycle, which will include the $75 you spend in Feb, the $50 still outstanding on the January balance, and the interest on that $50. Now this is where the APR thing gets confusing because even though the rate is 10%, the interest won’t be 10% of $50. This is because you’ve only borrowed the $50 for a few weeks, not a whole year. The interest is actually calculated daily, which is only fair because if you buy something on the 1st of the month you’re borrowing money for longer than if you buy something on the 28th. So back to our example, and let’s say you have enough money in your account to pay off the whole balance, so that’s what you do. When the bill comes in at the end of April, it’ll just be for the money you spent on the card in March, because you’ve paid off everything you spent in January and February.

I hope that makes sense! The main pitfall with credit cards is spending more than you can afford to pay back. If you’re spending $100 on the card each month and only paying back $75, the interest on the remaining $25 each month will start to build up.

But if you get a card and use it wisely it will help to build up your credit score. When you get your first card the interest rate may be through the roof and the spending limit may be very low (I think my first card only had a £200 limit). Don’t worry about any of that. Use the card to buy things you’d be buying anyway – things like groceries, gasoline, essential clothes etc. Don’t treat yourself or think of it as free money, because it isn’t. And don’t think that because you’re not spending the cash in your bank account that you can slurge that either – you’ll need that money to clear the credit card bill when it arrives.

Getting a credit card and using it properly will show lenders that you’re sensible with money and not a high risk. Therefore, they’ll be more willing to lend you money later on for larger purchases, like a house or car.

I’ve got a direct debit set up on my credit card so the balance is automatically cleared every month. I don’t even know what the interest rate is on the card, because I don’t pay interest on it any more (I did when I was younger but that was a loooooong time ago now!) I mainly use the card for everyday purchases but even if I do use it for a larger purchase it’s always something I know I can afford.

And in response to your final question, apply for all of them. If you get sent more than one card, only use one of them. Cut the others in half and throw them away.