APR: What is it and how does it work?
APR is short for Annual Percentage Rate, and it’s the interest rate you pay on a loan over the course of a year. It includes any fees or extra costs associated with the loan, and it’s expressed as a percentage of the total loan amount. Lenders are legally required to show you the APR before you enter into a loan agreement. APR rates are subject to change.
The APR on a personal loan ranges from is 10.99% – 35% as an example, based on creditworthiness.
APR is important because it’s a true reflection of the overall cost of your loan, including both the interest rate and any fees charged. When comparing different types of credit, make sure you compare APRs to get a true apples-to-apples comparison of costs.
The different types of APR
There are different types of APRs, and it’s important to know which one you’re looking at when you’re trying to compare different credit cards or loan offers. Here are brief explanations of the most common types of APRs:
Nominal APR: This is the simple interest rate you pay on a loan, without taking into account any fees or compounding. So, if you have a credit card with a 20% nominal APR and you make a $100 purchase that you don’t pay off at the end of the month, your interest charge for that month will be $20.
Effective APR: The effective APR is the actual rate you pay after taking into account compounding and fees. It’s generally higher than the nominal APR. For example, let’s say you have a credit card with a 20% nominal APR and a $3 monthly fee. The effective APR would be higher than 20%, because the monthly fee would be added to your outstanding balance and accrue interest as well.
APY (Annual Percentage Yield): The APY is generally used when talking about savings accounts and other interest-bearing accounts. It takes into account compounding, so it’s generally higher than the interest rate. For example, if you have a savings account with a 1% interest rate and it compounds monthly, your APY would be 1.008%.
How APR affects your loan
The APR is different from the interest rate because it includes any fees or extra costs associated with the loan. For example, if you take out a mortgage with an interest rate of 3.5% and closing costs of $3,000, your APR would be 3.8%.
Why is this important? Because the APR is what determines your monthly payments and the total amount you’ll pay back over the life of the loan. The higher your APR, the higher your monthly payments will be and the more interest you’ll pay over time.
APR and credit cards
Your APR is the rate you’re charged on your credit card balance — annual percentage rate. An APR is a yearly rate, but your credit card company will calculate your interest charges daily.
Credit card issuers are required to disclose the APR before you apply for a credit card. The APR is usually a variable rate, which means it can change over time. The issuer must give you 45 days’ notice of any interest-rate increase.
The Truth in Lending Act (TILA) requires lenders to disclose the annual percentage rate (APR) so that borrowers can compare credit terms more easily. The law applies to closed-end loans, such as mortgages and car loans, and to open-end lines of credit such as home equity lines of credit (HELOCs) and credit cards. The calculated APR includes not only the interest expense on the loan but also all other fees and charges incurred during the life of the loan, including points, insurance premiums, and certain prepaid finance charges
APR and mortgages
The acronym APR stands for Annual Percentage Rate. This term is commonly used in the mortgage industry to describe the total cost of borrowing on a yearly basis, including interest, points, fees, and other charges paid by the borrower to obtain a loan.
While APR is expressed as a percentage rate, it is important to remember that it is not the same as your interest rate. Your interest rate is the percentage of your loan amount that you will pay in interest over the life of your loan. APR includes your interest rate as well as certain other costs of borrowing, such as points, fees, and other charges that may be required to obtain your loan.
When shopping for a mortgage, it is important to compare both the interest rate and the APR so that you can choose the loan that is right for you.
APR and personal loans
The APR is the amount of interest you pay each year on a loan, expressed as a percentage of the loan balance. It includes any fees or additional costs associated with taking out the loan.
For example, if you take out a $10,000 personal loan with an APR of 10%, you’ll pay $1,000 in interest annually.
If you compare two personal loans and one has an APR that’s two percentage points higher than the other, you’ll pay an extra $200 in interest each year if both loans have the same term length. In general, the shorter the loan term, the lower the APR will be.
APR and student loans
The APR on a student loan is the amount of interest you will pay each year, expressed as a percentage of the loan balance. The APR includes both the interest rate and any fees charged by the lender. The goal of choosing a student loan with a low APR is to save money on interest over the life of the loan.
Federal student loans have fixed APRs that do not change over the life of the loan. Private student loans generally have variable APRs that can increase or decrease over time.
For variable-rate private student loans, the APR may increase or decrease when there is a change in the index used to determine the interest rate. The index is generally based on different Treasuries, such as LIBOR (London Interbank Offered Rate) or COFI (Cost of Funds Index).
The pros and cons of APR
An annual percentage rate (APR) is a yearly rate that represents the true cost of borrowing money. It includes the interest rate as well as any other fees or charges associated with the loan.
The APR is the standardized way of expressing the cost of borrowing money, and it’s important to understand how it works before you apply for a loan. Here are the pros and cons of APR:
- The APR reflects the true cost of borrowing money, including all fees and charges.
- It makes it easy to compare different loans from different lenders.
- It can help you identify loans with hidden fees or high interest rates.
- The APR can be confusing and difficult to understand.
- It doesn’t include all costs associated with a loan, such as prepayment penalties.
How to get the best APR
Annual percentage rate (APR) is the annual rate that is charged for borrowing, expressed as a single percentage number that represents the actual yearly cost over the term of a loan. This includes any fees or additional costs associated with the loan. For example, if you take out a $100 loan with a 10% APR, you would be required to pay back $110 at the end of the year.
There are a few things you can do to get the best APR possible:
- Shop around and compare APRs from different lenders.
- Check your credit score and work on improving it. A higher credit score will usually qualify you for a lower APR.
- Ask about discounts. Some lenders offer discounts for autopay or making extra payments.