What Is a Purchase Rate on a Credit Card?
Demystify the credit card purchase rate. Learn how this key interest rate impacts your credit card balance and the true cost of borrowing.
A purchase rate on a credit card represents the interest charged on new purchases when the outstanding balance is not paid in full by the payment due date. This rate is a fundamental component of credit card agreements, directly influencing the cost of borrowing for everyday transactions. If a balance is carried over from one billing cycle to the next, this rate determines the finance charges applied to those purchases.
What the Purchase Rate Represents
The purchase rate is typically expressed as an Annual Percentage Rate (APR), which signifies the yearly cost of borrowing. While interest and APR are sometimes used interchangeably for credit cards, the APR encompasses the total annualized cost, including the interest rate applied to your balance. The purchase APR is specifically applied to the balance of purchases made with the card that are not paid off by the due date.
To calculate interest charges, the annual purchase APR is converted into a daily periodic rate. This is done by dividing the APR by 365. This daily rate is then applied to the outstanding balance. The purchase rate differs from other potential credit card rates, such as those for cash advances or balance transfers, which often have different and sometimes higher APRs.
How Purchase Interest is Calculated
Credit card interest on purchases is most commonly calculated using the average daily balance method. This approach considers the card’s outstanding balance for each day within the billing period. To determine the average daily balance, the daily balances are summed up and then divided by the number of days in the billing cycle.
Once the average daily balance is established, it is multiplied by the daily periodic rate and then by the number of days in the billing cycle to arrive at the total interest charge. For example, if a card has a 20% APR, its daily rate would be approximately 0.0548% (20% divided by 365 days). This daily rate is applied to the average daily balance, and interest can compound, meaning that interest may be charged on previously accrued interest.
The Role of Grace Periods
A grace period is a defined period, typically between the end of a billing cycle and the payment due date, during which interest is not charged on new purchases. To benefit from this grace period, the cardholder must pay their entire outstanding balance in full by the payment due date. If the full balance from the previous billing cycle is not paid, interest may be charged on new purchases from the transaction date.
Grace periods generally apply only to new purchases and not to other transaction types, such as cash advances or balance transfers, where interest often begins accruing immediately. While not legally required, most credit cards offer a grace period, which typically ranges from 21 to 25 days.
How Purchase Rates Are Determined
Purchase rates offered on credit cards are influenced by several factors. A primary determinant is the applicant’s creditworthiness, which is largely reflected by their credit score. Individuals with higher credit scores are generally perceived as lower risk and may qualify for lower purchase rates. Conversely, those with lower scores might be offered higher rates.
The specific credit card product also plays a role in rate determination. Some cards are designed with lower APRs as a primary feature, while others, such as rewards cards, might have higher standard purchase rates. General market interest rates, like the prime rate, can also affect credit card APRs, particularly for variable-rate cards.