raverxhouston, somebody will correct me if I mess any of this up, but I’ll give it a shot.
The Annual Percentage Rate (APR) on any kind of loan is the percentage of your balance that you’d owe in finance charges if you maintained that balance for a year, in the absence of compounding. I’ll go into more detail on that in a minute.
My credit card (and, I suspect, most others) actually calculate finance charges on a daily basis. Say the APR is 14.9%, then the Daily Periodic Rate (DPR) is 14.9%/365 = 0.04082%. Each day, interest (aka finance charges) accrues at (0.0004082)*(That day’s balance).
These charges are recorded daily over the course of the (monthly) billing period, and after 31 (or 30, or whatever) days, the finance charge is then added to your balance. It’s important to note that, while they are calculated based on each day’s balance, finance charges are added to your balance only once per month - at least for monthly compounding, which I believe is the norm.
Now, the fun thing (for them) is that these finance charges are part of your balance for the next billing period, and earn finance charges themselves. This is what’s known as compounding - interest on the interest (on the interest on the interest on the…)
If, somehow, you were not required to make payments on a constant balance of, say, $1000 for an entire year at a (monthly compounded) APR of 14.9%, you would owe more than $149 in finance charges at the end of the year. Since finance charges are compounded monthly, it would actually work out to something like…
:: punches madly into calculator ::
$159. Or something close to it.
Now, most cards require to you make at least some minimum payment each month, which further complicates things. I’ve never bothered to investigate just how they arrive at the minimum payment amount printed on the statement, but among other things I think it’s supposed to ensure that you at least keep up with the finance charges. Not certain about that.
Now, looking at your numbers, I’m having trouble reconciling them. The DPR for your APR is 0.04082%. If you maintained a balance of $2000 for the entire (31-day) month, I’d expect to see a finance charge of $25.31, not $40.
Couple of possibilities that I can think of:[ul][li]Was the Average Daily Balance for the month actually $2000, or was is perhaps higher? Did you pay off a large chunk of the previously higher balance halfway through the month?[/li][li]Is there possibly a Minimum Finance Charge? $40 sounds really high if that’s it, though - on my card it’s $0.50.[/li][li]Did you take out any cash advances? They’re often at a higher rate (although on my card it’s only a couple of percent higher).[/li][/ul]
Hmm…I don’t really know how they got $40. If it’s not any of the above possibilities, we’ll have to wait for somebody to correct whatever I’ve omitted or done wrong. I also apologize if I misinterpreted your question and just gave you a lecture on something that you fully understand. :o
[wild, uninformed rambling]
My take on APR: it’s sort of an abstract number, since rare are the situations in which you actually accrue that percentage in finance charges over an entire year - compounding sees to that. However, it’s a fairly convenient benchmark for quoting interest rates (you could regard it as the DPR*365) and for comparing different terms to one another.
Monthly rates might be more relevant since that’s the period of compounding, but since months aren’t the same number of days the “MPR” isn’t a constant for all months. DPR is great, but nobody wants to try to deal with numbers that small: “I got a great loan at a daily interest rate of 0.0387%!” Quoting the numbers on an annual basis is simply more convenient.
[/wild, uninformed rambling]