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APR's and the truth

Credit card companies today beseech gullible consumers by offering incredibly low introductory APR rates. The rates revert back to their higher counterparts upon expiration of the offer period.

But what does APR mean besides Annual Percentage Rate?

When a credit card company loans you money (like when you dont pay the full balance at the end of the month) it charges you interest for it. The interest charged is not computed annually. It's charge periodically, usually every month.

Truth in lending laws require companies diclose the APR. The APR is supposed to tell you the annualized rate, but it is not the effective rate. The APR is:

number of periods x interest rate

Thus an APR of 12% if calculated monthly would indicate a 1% interest per month.
Unfortunately interest is not charges only on the principal during each period. Interest is charge on the principal plus unpaid interest. (thus, if you owe $100 at 1% a month, the first month you owe $101 but the second month the interest is charges on $101 resulting in your owing $102.01 the third month). So while the APR might say 12% the effective interest rate when charged 1% every month is

(1+(interest rate))^12 = (1.01)^12 = 1.1268 = 12.68%

So given an APR you can calculate the effective interest rate by:

(1 + APR/term)^term = (1 + .12/12)^12 = 1.1268 = 12.68%

Posted at May 5, 2002 11:51 PM