Everything to Know About APR
It’s a term seen frequently: APR. Find a loan with a low APR. Compare offers to find the best APR.
But what is APR? And how does APR effect loan and credit card offers?
What is APR?
APR stands for annual percentage rate. That rate is the total fees and interest you’ll pay on a financial product, like a loan or a credit card, over the course of a year.
APR is not exactly the same as an interest rate, however. An interest rate is just how much interest is charged on a loan or line of credit. The APR includes all of the costs involved with the financial product including the interest, the fees and also potential discounts. When you compare the APR between loans, it presents a more complete picture as you make your financial decision.
APR even looks a lot like the interest rate on a loan. Both are shown as a percentage. But APR is the more complete numerical ratio. Both interest rates and APR can be fixed, meaning they don’t change over time, or they can be variable, which means they fluctuate.
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How is APR calculated?
APR is comprised of three things: interest, fees, and discounts.
Interest is how much the bank is charging you to borrow money through a loan or a credit card. The interest rate is a percentage of the balance and can vary wildly based on the type of loan and your credit score. The higher your credit score, the lower the interest rate typically will be.
Fees are the additional payments for your loan or line of credit outside of the interest payment you make every month. Fees might be monthly or annually. This fee is included in the total APR calculation. Discounts are savings for certain things. Some lenders offer discounts for automatic payments, for example. Discounts will lower your APR while fees and interest will raise it.
APR with loans
A loan is a one-time, lump sum of money that you borrow for a specific purchase. You get a mortgage to buy a house. You get a personal loan to buy a boat, renovate a home or for debt consolidation. You get a car loan to buy a new car.
That loan will have a single APR associated with it. Note that while you might have only one APR for the loan, it might not be fixed. It can fluctuate or adjust over time.
A mortgage, for example, might be a loan with an APR of 4.7036%. That APR is comprised of an interest rate of 4.50% and closing cost fees of $4,800. If that is a fixed APR and interest rate, you can expect your payments to be identical every month for the entire life of the loan.
If the APR is variable, however, you may see the loan payments go up, or possibly go down, over the months or years of the loan’s life.
As for comparing APR to find the best deal, if the first loan you’re offered has an APR of 4.7036% and the second has an APR of 4.4035%, even if the interest rate on the second loan is higher, you’ll still wind up paying less out of pocket thanks to the lower APR.
APR and credit cards
A mortgage, car loan, or personal loan has a single APR for the lump sum you initially borrowed. A credit card, on the other hand, can have multiple APRs based on what you are purchasing. Unlike a loan, a credit card is effectively a line of credit. It’s also worth noting that a credit card is one of the most expensive ways to borrow money, in terms of APR.
When you take out a new credit card, it will have the APR detailed in the fine print. You will see that there is likely a different APR rate for purchases, cash advances and balance transfers. Sometimes there will be promotional APR offers available as well.
A credit card might have a promotional APR of 0% for the first twelve months. After twelve months, the APR for purchases jumps up to 16.99% APR. That same card might have a special offer of 0% APR for purchases, but still charge you 24% APR for cash advances during that same time period.
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It’s important to remember that APR only applies to credit card purchases if you hold a balance on the card. If you pay your balance off every month, you will effectively always pay an APR of 0%. But if you fail to pay the entire balance every month, high APR rates will kick in almost immediately making it hard to pay the balance down with just the minimum payment.
Lenders are required by law to reveal the APR for their loans or credit cards. This makes it easy tocompare products from different lenders by effectively comparing apples to apples. Many lenders will advertise a range of APR percentages, but you will be offered a specific range once you’ve applied for a loan or a line of credit. The chief factors in determining which APR you are offered are your credit score and your repayment history. The better you’ve been with the credit in the past, the less it will cost you to borrow money now.
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