Credit cards, loans, mortgages—they all come with an APR. But what is APR, and why does it matter? Understanding this three-letter acronym is key to managing your credit. So, let’s break it down and discover everything you need to know about understanding APR.
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APR, explained
APR stands for annual percentage rate. It’s a term you’ll often hear when applying for credit cards, personal loans, and other forms of credit.
Essentially, APR is the cost of borrowing money over the course of a year, expressed as a percentage. It includes both the interest rate and other fees associated with the credit product.
Several factors can affect APR, such as:
- Interest rate: The interest rate is the percentage of the amount borrowed that you’ll pay back as interest. It’s a big part of APR. The higher the interest rate, the higher the APR, and the more you’ll pay over time.
- Your credit score: Lenders use your credit score to determine how risky of a borrower you are. They consider you less risky and may offer you a lower interest rate if you have a high credit score. On the other hand, if you have a low credit score, lenders consider you riskier and may charge you a higher interest rate. Keeping a good credit score can help you qualify for the best APR.
- Fees: Some loans have fees like application fees, processing fees, or origination fees. Adding these to the overall cost increases the APR.
- Length of the loan: The APR might be lower if you have more time to repay the loan. But if you pay over a longer time, you could end up paying more interest overall.
APR is important because it allows you to compare the total cost of borrowing across different credit products. It helps you to understand the true cost of borrowing money and make an informed decision about which credit product to choose.
How does APR work?
Typically, when you borrow money, the lender will require you to pay back the borrowed amount along with interest over a specified period of time. The interest rate is the percentage of the amount borrowed that you’ll pay back as interest. For example, if you borrow $1,000 with a 10% interest rate, you’ll pay back $1,100 over the course of the loan.
The APR is a more comprehensive measure of the cost of borrowing money because it includes all fees associated with the credit product. For example, if you borrow $1,000 with a 10% interest rate and a $50 origination fee, your APR would be higher than 10%. This is because the APR takes into account the total cost of borrowing, not just the interest rate.
It’s critical to understand APR when comparing credit and loan offers because it allows you to compare the total cost of borrowing across different products.
For example, if you’re considering two personal loans with different interest rates and fees, the APR will give you a more accurate picture of which loan is actually more expensive. Likewise, comparing APRs can help you with choosing the right credit card.
APR vs. APY
APR (annual percentage rate) and APY (annual percentage yield) are like two sides of the same coin.
The APR is typically used to describe interest rates on loans, credit cards, and other forms of credit. It helps you calculate how much extra you’ll pay to borrow money from a bank or lender over the course of a year.
APY is typically used to describe interest rates on saving accounts, CDs, and other investments. It helps you calculate how much interest you could earn when you deposit money with a bank or credit union.
APR vs. interest rate
The interest rate is the percentage a lender charges you for borrowing money. It’s the cost of borrowing, expressed as a percentage of the loan amount. This rate is applied to your loan balance to determine how much interest you’ll be pay over time.
APR takes it a step further. It includes not only the interest rate but also some additional fees and costs associated with the loan.
These fees might include things like origination fees, closing costs, and other charges that are part of the loan. The APR gives you a more comprehensive picture of the true cost of borrowing by incorporating these extra charges.
Types of APRs
You might encounter several types of APRs when applying for credit products. Here are some of the most common types.
- Purchase APR: This is the APR that applies to purchases made with a credit card. It’s the rate you’ll be charged if you don’t pay your credit card balance in full each month.
- Balance transfer APR: Applies to balances transferred from one credit card to another. It’s often lower than the purchase APR, but may only apply for a limited time.
- Cash advance APR: This APR applies to cash advances taken out on a credit card. It’s typically higher than the purchase APR and may incur additional fees.
- Introductory APR: This temporary APR is often offered as a promotional rate when you first open a credit card or take out a loan. It’s usually lower than the regular APR and may apply for a limited time.
- Penalty APR: A higher APR that may be applied if you miss payments or make late payments on a credit product. It’s often much higher than the regular APR and can make it difficult to pay off your debt.
Wondering what APRs you’re currently paying? Pull up your credit card statement or loan statement to find out. Most are listed on there. You can also call your lender and ask.
Fixed APR vs. variable APR
All APRs fall into one of these two groups: fixed or variable.
A fixed APR remains the same throughout the entire loan Your monthly payment and interest rate at the beginning will be the same when it’s paid off. Fixed APRs can be nice because they’re predictable and can make budgeting easier. Personal loans typically have fixed interest rates.
A variable APR is an adjustable-rate APR that can change over time based on market conditions. It’s often tied to an index, like the prime rate. If the index changes, your APR and monthly payment will change, too.
A variable interest rate may be lower than a fixed rate initially, but it can also be more unpredictable and may be more difficult to budget for. Credit card APRs are usually variable.
In most cases, you can’t choose whether your APR is fixed or variable. It’s pre-determined by the lender or credit card issuer. However, some lenders may offer both fixed and variable APR options for things like mortgages or personal loans, so you can choose which one you prefer.
Grasping the concept of APR
APR is an important concept to understand when it comes to borrowing money. It’s a measure of the total cost of borrowing, including both the interest rate and fees.
By understanding APR and the different factors that can affect it, such as the interest rate, fees, and length of the loan, you can make an informed decision about which credit product is right for you. Whether you’re applying for a credit card or loan, understanding APR can help you save money and make the most of your financial resources.
Written by Cassidy Horton | Edited by Rose Wheeler
Cassidy Horton is a finance writer who’s passionate about helping people find financial freedom. With an MBA and a bachelor’s in public relations, her work has been published over a thousand times online by finance brands like Forbes Advisor, The Balance, PayPal, and more. Cassidy is also the founder of Money Hungry Freelancers, a platform that helps freelancers ditch their financial stress.
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