What Is An APR?

Learn what APR (Annual Percentage Rate) is, how it is calculated, and how to avoid credit card interest charges!

Whether you’re applying for a credit card, personal loan, or mortgage, understanding what APR (Annual Percentage Rate) means and how it works can help you make informed financial decisions. It’s a crucial tool for assessing the cost of borrowing.

It is more than just a number. Always compare the rates, read the fine print, and consider your financial goals when evaluating loans or credit card offers. This comprehensive guide will explain what APR is, its various types, how it’s calculated, and factors that influence it.

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What Is An APR?

It represents the annual cost of borrowing money, expressed as a percentage. APR includes not only the interest rate but also additional fees and costs associated with the loan. This makes it a more comprehensive measure of how much it'll all cost you compared to the simple interest rate. For example, if you take out a loan with a 10% interest rate but have additional fees that bring the total cost to 12%, your Annual Percentage Rate is 12%. By law, lenders must disclose it to borrowers, allowing you to compare offers and make better financial decisions.

Types of APRs

• Fixed APR: it means that the rate remains constant over the life of the loan or credit agreement. This type provides stability and predictability in monthly payments, but it can't get lower. They are common in mortgages and car loans.
• Variable APR: this means that the rate fluctuates based on changes in a benchmark interest rate, such as the prime rate, which means that the APR will get higher or lower depening on it. It is common in credit cards and adjustable-rate mortgages (ARMs).
• Balance Transfer APR: this is the one applied to balances transfered from another credit card. It’s usually the same rate as the purchase one.
• Introductory APR: some credit card companies often offer a low or 0% introductory APR for a limited period, usually 6 to 18 months, to attract new customers. This can be really helpful to pay off debt from another card by balance transfering. After the introductory period, it reverts to the standard rate.
• Purchase APR: this is the rate applied to purchases made with a credit card. It can be fixed or variable, depending on the credit card agreement.
• Cash Advance APR: if you withdraw cash from an ATM using your credit card, this one applies to the amount you withdraw. It is usually higher than the purchase one. Cash advances also typically do not have a grace period, meaning interest accrues immediately.
• Penalty APR: if you’re more than 60 days late on payments, a penalty APR may be applied. This rate is significantly higher and serves as a deterrent for late payments.

APR vs. APY: What’s the Difference?

While the Annual Percentage Rate focuses on the cost of borrowing, APY (Annual Percentage Yield) measures the annual return on investment, taking compounding into account. Compounding refers to earning interest on both the principal and previously earned interest.

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How Is APR Calculated?

Lenders often use slightly different methods, but the core principle remains the same. Calculating it involves considering the interest rate, loan amount, and any additional fees. The formula is: APR = (((Interest charges + fees / loan amount) / Number of days in the loan term) x 365) x 100.

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What Can Impact It?

• Credit History: a higher credit score and a low debt-to-income ratio typically results in a lower APR because lenders see you as a lower risk.
• Loan Type: the type of loan (mortgage, personal loan, credit card) also impacts it. Secured loans, like mortgages, often have lower APRs than unsecured loans.
• Market Conditions: economic factors, such as changes in the federal funds rate, can influence APRs. When interest rates rise, it typically follow suit.

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