How is APR determined?

Discuss anything related to interest rates & fees, like balance transfer offers, low rate cards, annual fees, etc.
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im_mr_awesome
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How is APR determined?

Postby im_mr_awesome » Fri Jun 14, 2013 4:20 pm

I'm working on reducing my debt and planning for the future. Part of that is improving my credit, ditching or sock drawer-ing the low limit cards, increasing limits, and lowering APRs. Knowing how to reduce APR (as well as what lenders are giving the lowest APR) will go a long way toward my financial sanity.

I know there's the "Prime Rate" stuff, but how is everything determined? Store cards don't count--those are almost always a set rate and you're either approved or not. Credit cards are different...you can be approved with a 22.9% APR with a low limit like my Amazon card, or you can be approved with a 14.74% APR with a high limit on a Visa Signature card, but it's still an Amazon card.

Does anyone actually know what they look at to determine what APR they give you? Does it have any relation to the APR on your other cards?
Scores on the mend...
FICO: 650 (Discover/TU, 6/23/2016)
Cards I Use Citi Double Cash, Chase Amazon, Capital One QuickSilver
Sock Drawer Discover IT, Citi Diamond Preferred, AE Visa, QuickSilver One, Walmart CC, CareCredit, CreditOne (keeping for history for now)
Short Goal Reach 680


rockyrock
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Postby rockyrock » Sat Jun 15, 2013 5:58 am

If you read the fine print grantors will tell you the range of the APR for the cards they offer. Some are fixed, some variable, etc. They may offer tiers or it may just have a starting and ending; where you fall depends entirely on your worthiness.

Non-reward cards usually offer much lower rates as they don't have to buy point/miles to distribute. Most I've seen are in the 7%-15% range depending on your credit worthiness.

Reward cards usually start around 15% and top out around 21% depending on your credit worthiness.

The major deciding factors are your creditworthiness and the lender/grantor.

All these numbers are based off what I have researched from lenders such as Chase, Amex, Discover, and a few CUs. YMMV
American Express (2005): Premier Rewards Gold & Blue Cash Preferred
Chase: Freedom & UA Club USAA: Signature Visa & American Express
Discover it Bank of Hawaii Hawaiian Airlines WEMC Synchrony Sam's MC
Navy FCU Platinum Visa Citi Double Cash & AT&T Access MC

flan
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Postby flan » Sat Jun 15, 2013 8:04 am

rockyrock wrote:If you read the fine print grantors will tell you the range of the APR for the cards they offer. Some are fixed, some variable, etc. They may offer tiers or it may just have a starting and ending; where you fall depends entirely on your worthiness.


Also, some issuers have more than one version of same card. (For instance, Discover has prime and 'near-prime' versions of the 'it' card. Different terms and conditions, different ranges of interest rates.) Also, one of their factors is how likely you are to pay interest. If your history suggests you're never going to pay interest, they may offer a lower rate, because they know they're not leaving money on the table, or they may give you the high rate because you know you don't care. Lenders have systems that are rational, to them, but not necessarily to anyone

MemberSince99
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Postby MemberSince99 » Sat Jun 15, 2013 8:26 pm

Great explanation guys! You guys are really on top of your information! :)

jojo
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Postby jojo » Sun Jun 23, 2013 2:01 am

Prime rate is an index that banks use to set their interest rates. It's the bank's cost to procure funds to loan to you, the borrower. The banks are in the business to make money, which means they have to charge you a rate that's higher than what they paid to procure the funds. If the bank's cost of funds is prime (currently set at 3.25%), they need to charge you an APR above prime to make money. The spread between prime and your APR is the bank's potential revenue. This is also why your APR is tied to prime. If the bank's cost of doing business goes up, they'll pass it on to you.

The second component of your APR is the % spread between prime and your APR. Banks determine that based upon your risk profile. Based on your credit scores, income, and assets - the lender will assign you a risk profile with a grade or score. This determines the likelihood that you'll pay back the money loaned. For example, an A grade from a bank means that 95% of the borrowers with this grade will pay back their loans so the lender has set an interest rate that will cover the 5% default and a nice profit margin for them. In the C grade group, only 70% of borrowers will pay back their loans, so the bank has to charge a higher APR to cover the 30% default rate and as well a profit margin. That's why the lower grades pay higher interest - to cover those in the same group that won't.

In the credit card world, the type of card is also a factor. If the bank offers a rewards program with the card where they're paying the borrower some cash back or perks, they need a higher APR to cover the cost of the rewards program. If it's a no frills card with no rewards and minimal administration costs, they might be willing to drop the APR.

Lastly, it costs a lot to administer a credit card. There's a lot of people, information systems, oversight, and other magic to make that credit card program work. That cost is also built into your APR and some banks are more efficient at this than others. You could also be paying for inept bank management who don't know how to manage costs.

I hope this helps. It's been about six years since I've worked in consumer lending, but I believe the same principles that applied back then are still in place now.

im_mr_awesome
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Postby im_mr_awesome » Mon Jun 24, 2013 7:12 pm

That's my kind of explanation! :D I knew APRs would be higher (or there would be annual fees) for rewards cards but I didn't even think about the percentage of people who might default on their loans. I do wish that payment history made a larger impact on scoring and determining APRs... I've never missed a payment and don't intend on ever missing one.
Scores on the mend...
FICO: 650 (Discover/TU, 6/23/2016)
Cards I Use Citi Double Cash, Chase Amazon, Capital One QuickSilver
Sock Drawer Discover IT, Citi Diamond Preferred, AE Visa, QuickSilver One, Walmart CC, CareCredit, CreditOne (keeping for history for now)
Short Goal Reach 680



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