- An APR is the cost of borrowing money, stated as a yearly rate.
- You can use APR to compare loan offers because it shows what you'll repay in interest, plus fees.
- APRs can be fixed or variable and are calculated as simple or compound interest.
Definition of APR
What does APR stand for?
The term APR stands for "Annual Percentage Rate" and represents the yearly cost of borrowing money, encompassing interest rates and any additional fees charged by the lender. APR is used for credit cards, personal loans, and mortgages.
Understanding the basics of APR
Unlike the simple interest rate, APR provides a more comprehensive look at the cost of a loan or credit, making it a critical tool for comparing different financial products. It's standardized across the financial industry to offer consumers a straightforward way to compare offers.
Types of APR
Fixed vs. Variable APR
Fixed APR means the interest rate remains constant over the life of the loan or credit agreement, offering predictability in repayment amounts. Personal loans and traditional mortgages are fixed-rate.
A variable APR can change over time based on the underlying interest rate movements, such as the prime rate, affecting monthly payments. Most credit cards have a variable APR that can change over time.
Introductory vs. standard APR
Introductory APR is a temporary, lower interest rate offered to new customers for a specific time, often 6-18 months. After the intro period ends, the standard APR kicks in.
Be wary of promotional APR offers, such as 0% interest periods, and understand what the APR will be after the promotional period is over. For instance, many credit cards offer 0% interest on purchases, but if you don't pay off your balance in full by the end of the introductory period, you'll be on the hook for interest charges. If you've already accumulated high-interest debt, you may want to consider a debt consolidation loan.
Penalty APR: when and why it's applied
A penalty APR is the interest rate that applies if you miss a payment or violate the terms of your credit agreement. This rate is usually much higher than the standard APR and can remain in effect for an extended period. A penalty APR can be triggered by just one late payment, so it's important to stay on top of your payments.
How APR works
How APR Is calculated
The APR of a loan represents the total cost of borrowing over the course of one year. It's calculated by combining the interest rate with any additional costs, such as origination fees or closing costs, and spreading these costs over the loan term.
For credit cards, the APR indicates the annualized cost of carrying a balance, providing cardholders with a clear understanding of the total cost of borrowing over a year.
How APR differs from interest rate
While often used interchangeably with interest rate, APR includes the interest rate plus other fees and costs associated with the loan, while the interest rate is just the cost of borrowing the principal amount,
Many loans for bad credit, for example, charge an origination fee, which is calculated into the APR for the total cost of borrowing.
Why APR matters
APR's impact on loan costs
The APR directly impacts the total amount you'll pay back to the lender, including both the principal and the cost of interest and fees over a year. A lower APR means lower overall borrowing costs, making it essential to seek competitive APRs when shopping for loans or credit cards.
Higher APRs will also increase your monthly payment on fixed-term personal loans, which may make it more difficult to make your payments each month.
How APR affects credit card balances
APR determines how much interest you'll pay on any balance you carry. If you only make minimum payments, a high APR can drive you into debt quickly. Paying your balance in full every month or keeping it as low as possible can help you avoid paying extra interest.
Choosing loans based on APR
You should compare APRs from multiple lenders or credit card issuers to find the best rate possible for your financial situation. A lower APR can save you money, especially with long-term loans. When comparing loans, APR helps you understand the total cost of borrowing, not just the interest rate.
Common examples of APR in financial products
APR in mortgages
A mortgage APR includes the interest rate and fees, such as points and closing costs, giving borrowers a full picture of the loan's cost. Comparing APRs from different mortgage lenders can help you save money on your mortgage.
APR in credit cards
Credit card APR applies to any cardholder's balances, but the rate may vary for purchases, cash advances, or balance transfers. Paying in full each month avoids interest charges.
APR in personal loans
Like the examples above, the APR on a personal loan APR combines the interest rate and fees. A lower APR means a less expensive loan.
FAQs about APR
What is a good APR?
Generally speaking, the lower the APR, the better. The average credit card APR was nearly 21% in 2023, so anything below that would be considered good. The APR you get often depends on your credit score and current market rates.
Does APR include fees?
Yes, APR includes fees like loan origination costs and interest rates. It gives you a complete picture of the cost of the credit you use.
Is APR the same as interest rate?
No, a loan's APR is broader than the interest rate alone. It includes the interest rate plus any additional costs or fees, showing the total cost of borrowing.
How can I lower my APR?
You can lower your APR by negotiating with your lender, improving your credit score, or transferring your balance to a card with a lower rate. Shopping around for the best offers also helps.
Why does APR vary by credit card type?
APR varies by card type because of differences in risk and features. Rewards cards may have higher APRs, while secured cards often have lower rates due to the collateral required for opening an account.
Do introductory APR offers affect my credit?
Introductory APR offers don't directly affect your credit, but opening a new card may result in a temporary dip in your score due to a hard inquiry. You can improve your credit in the long run by using your card responsibly during the promotional period.
