Annual Percentage Rate (APR)

March 22, 20233 min read

{noun} The total annual cost to borrow money, including fees, expressed as a percentage.

What is Annual Percentage Rate (APR)?

Annual percentage rate (APR) is the cost of borrowing money on an annual basis. APR is expressed as a percentage, to make it easier to compare the cost of credit.

APR and interest rate are sometimes used interchangeably, however, APR and interest rate are different. APR includes both interest plus fees applied over the course of a loan. Because APR is a more complete measure of the cost of credit, it is usually higher than the interest rate.

How is Annual Percentage Rate Calculated?

To calculate APR on a loan, you’ll need to know a few other numbers first:

Interest: The total interest charges paid over the life of the loan, also known as the cost of borrowing money.
Fees: Review the terms and conditions of the loan to find the fees that apply to your loan. Fees vary by loan type and lender.
Principal: The original loan amount.

Days in the Loan Term (n): Since APR measures the annual cost of borrowing money, multiply 365 (days) by the number of years in the loan term. For loan terms under one year, use the number of days.

The formula to calculate APR is:

The steps to calculate APR are:

  1. Find the interest charges

  2. Add the fees

  3. Divide the sum by the principal balance

  4. Divide by the number of days in the loan’s term

  5. Multiply by 365

  6. Multiply by 100

Credit Card APRs

Credit card APRs do not reflect fees and since a credit card has no set loan amount or fixed repayment term, its APR is simply its interest rate.

Under the Truth in Lending Act, passed in 1968, lenders and other financial institutions must disclose APR when offering credit.

Why is Annual Percentage Rate Important?

Knowing the annual percentage rate helps you understand the true cost of borrowing.

For example, all lenders are required to disclose APR, which makes it easier to compare loans from different banks and make a more informed borrowing decision.

Are There Different Types of APRs?

There are different categories of APRs depending on the type of financial product.

Credit Card APRs

Credit cards have several APRs that may apply to different transactions or account activities.

  • Purchase APR: The rate you pay for purchases.

  • Balance transfer APR: The rate applied if you use a card to pay down balances on other credit cards or loans.

  • Cash advance APR: The rate charged on ATM withdrawals or cash-equivalent transactions, like money-order purchases.

  • Introductory APR: A promotional interest rate for a limited period of time that is lower than the card's regular APR, sometimes as low as 0 percent APR.

  • Penalty APR: A higher-than-normal rate that results from violating a card’s terms of service.

What’s the Difference Between Fixed and Variable APRs?

APRs can be fixed or variable. A fixed APR remains unchanged for the life of your loan. A variable APR fluctuates in sync with a published market index, like the U.S. Prime Rate.

Adjustable-Rate Mortgages

Home loans with variable interest rates are called adjustable-rate mortgages (ARMs). With an ARM, your APR is fixed for an initial term (typically one, three, or five years, but sometimes as long as 10 years), then resets every six or 12 months, based on market rates.

What Affects APR?

The APR you're offered depends on a few factors:

  • Whether a loan or line of credit is secured or unsecured

  • Current economic conditions

  • Your credit history

Lenders may also consider your income and assets, down payment, and where you live when determining your APR.

How Do You Get a Good APR?

Getting the best APR on a loan or credit card typically requires shopping around.

Start by prequalifying with multiple lenders. Prequalifying is a quick process where you provide some basic information about your income and borrowing goal. Then, lenders respond with a preliminary, non-binding estimate of the loan amount and APR. This is typically done through a soft credit check, which doesn’t impact your credit.

Then, compare the preliminary offers and submit a full application to your lender of choice. With your detailed financial information and a hard credit inquiry, which will impact your credit, lenders can make a formal loan offer that includes your APR, fees, and repayment terms.

If you’re unhappy with the terms you’re offered (or if lenders decline your applications), your credit history might be the culprit. If this is the case, you can work to pay down your existing debts and bring late payments current, which can improve your credit score and chances for approval over time.

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