What is My APR, Really?

When it comes to credit, sometimes even the simplest notes we receive from credit card companies can seem confusing. One Credit.com reader experienced this confusion recently, right after she got approved for her new credit card.

Her approval letter contained a puzzling message at the top.

“So what does ‘Your APR will be Prime Plus 14.74’ really mean?!?” she wrote recently in response to a Credit.com story.

Good question. What this means is that the interest rate on her credit card will be based on the Prime rate, which is how much interest banks charge each other to lend each other money overnight to cover all the transactions their customers made the previous day. The Prime rate is set by the Federal Reserve, which can lower the rate to try and spur the economy, or raise it to help curb inflation.

Right now, the Prime rate is 3.25 percent. So that means the interest rate on her new card will be 3.25 + 14.74 = 17.99 percent. (The 14.74% may be a reflection of your credit score. Generally, the lower your credit score, the higher your interest rate will be. If you don’t know your credit score, or what’s in your credit report – which determines your credit score – you can use Credit.com’s free Credit Report Card to learn the basics.)

There is an interesting backstory here, says Gerri Detweiler, Credit.com’s consumer credit expert. It used to be common for credit cards to charge fixed interest rates. In recent years that started to change, and variable interest rates became the norm. Most variable rates are pegged to some sort of market or interest rate index, and the Prime rate is one of the most common pegs, Detweiler says.

This trend towards variable rates picked up speed tremendously with passage of the Credit Card Accountability and Responsibility Act of 2009, usually referred to as the CARD Act. The law imposed limits on how credit card issuers may change cardholders’ interest rates, and requires better notification of rate increases. Those provisions turned the march toward variable rates into a stampede.

“With the CARD Act, they knew they’d have less ability to raise interest rates, so a lot of them switched to variable rates,” Detweiler says. “It’s very unusual to see true fixed rate credit card offers anymore.”

To our Credit.com reader: You’ll be happy know that your confusion about your new credit card statement has deep roots. The reason why it’s confusing is that it may be totally new.

For more Credit 101, check out these posts:

Image: ryanmilani, via Flickr

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