digest
Short Summary
Main recommendation: Avoid carrying balances on credit cards, and when you do, compute the effective APR rather than trusting the stated APR, because the stated figure understates the true annual cost. In the example, a 22.9% APR with a 0.06274% daily periodic rate compounds to an effective APR of about 25.7%.
Key Points
- A card's stated APR (22.9% here) is found by multiplying the daily periodic rate (0.06274%) by 365 days, which ignores compounding.
- The effective APR compounds the daily rate daily: (1 + 0.0006274)^365 − 1 ≈ 25.7%.
- The gap of roughly 3 percentage points matters a great deal over long balances, since interest is charged on previously accrued interest.
- The effective APR figure does not yet include penalties or other fees the issuer may add on top.
Details Worth Noting
- Concrete instructions:
- Find the daily periodic rate printed next to the APR on the card's disclosure.
- Convert it to a decimal by dividing by 100 (0.06274% becomes 0.0006274).
- Add 1 to that decimal to get the daily growth factor (1.0006274).
- Raise the growth factor to the 365th power, meaning multiply it by itself 365 times.
- Subtract 1 from the result and convert to a percentage to get the effective APR.
- The example uses $100: a simple 365x multiplication of the daily rate suggests the stated 22.9% APR, but Sal explains that daily compounding means you wouldn't just owe $122.90 after a year—the true growth is about 25.7%.
- Compounding is what drives the difference: each day's interest is added to the balance and earns interest the following day.
- The speaker advises not carrying balances at all, since high interest rates mean you pay interest on old purchases long after their value has faded; if you must carry a balance, pay close attention to the effective rate.
Bottom Line
The advertised APR understates what a card really costs when interest compounds daily, so the effective APR is the number to check if you ever carry a balance.
