An APR, or annual percentage rate, is a rate which measures the cost (sometimes referred to as the finance charge) to borrow money.
It’s easy to confuse an APR with an interest rate, which is the percentage you’re charged on the principal amount (the amount of money borrowed) . An APR is inclusive of fees, such as the closing costs on a mortgage or an origination fee on a personal loan, and the calculation is based on the amount financed, the finance charge, and how payments are scheduled
Understanding how an APR works will give you a better handle on managing your debt and help you make more strategic decisions when choosing financial products.
How does APR work?
For credit cards, for example, interest is actually being assessed daily, whereas some other products may assess interest on a monthly basis. Also different types of products may have very different closing costs causing a much larger discrepancy between the interest rate and the APR.
No matter what kind of personal credit product, the APR should be disclosed to you prior to opening the account on a Truth in Lending Disclosure.
The Truth in Lending Disclosure also contains other important information such as:
- Finance Charge
- This is cost of borrowing expressed a dollar amount
- Amount Financed
- This is the amount of credit provided to you. For example, if the cost of borrowing includes a prepaid origination fee, this amount would reflect what you receive after the origination fee is deducted.
- Total of Payments
- This figure provides you the total amount you will pay if you make payments according to the payment schedule. This amount includes the interest and principal paid back.
- Payment Schedule
- The payment schedule summarizes monthly payment amounts, when those amounts are due, and how many payments will be due.
- Other Fees
If there are other fees such as a late payment charge, this fee information will be notated here.
Different types of APR: Credit cards vs Personal loans
How much you actually pay on your credit card depends not only on the interest rate, but also on how you manage your account. Do you pay off the balance in full each month or do you only make minimum payments?
Interest is assessed on a daily basis if you carry a balance from month to month. If you pay your card in full every month, you may not pay any interest at all. As the balance on your principal is paid down, your APR may also go down depending on the card issuer’s policies.
Mostly, you can avoid paying interest on credit cards if you pay your balance in full each month by the due date.
Credit cards also have a variety of APRs, including:
|Introductory||The teaser or promotional rate, which can be zero. This is a temporary offer and usually applies to specific transactions like balance transfers and cash advances.|
|Penalty||Typically the highest APR that may be applied to you if you violate the terms and conditions, like making a late payment.|
|Cash advance||The cost to borrow cash from your credit card.|
|Purchase||The rate for putting purchases on your credit card|
APR on a personal loan
Similar to an APR on a mortgage, a personal loan APR includes interest and fees.
You can use Upstart’s loan calculator to find out what kind of APR you can expect to pay, based on the loan amount and repayment terms.
What does a 0 percent APR mean?
Credit card companies often promote a 0 percent APR to entice people to apply. These are also known as promotional offers, which are temporary. Typically, you can take advantage of the 0 percent offer for a set number of months.
While the 0 percent sounds great, there may be other fees to be aware of, such as a balance transfer fee. A balance transfer allows you to move one card’s balance to another. Zero percent offers allow you to do this, but at a percentage of the balance, typically 3 percent.
If you have $1,500 on one card and want to move it over to your 0 percent card that charges a 3 percent fee, it’ll cost you $45.
The lower the APR, the less you may pay over the life of a loan. For credit cards, you can strategically avoid paying too much interest as long as you pay your balances in full within the given grace period.
Knowing the APR helps you understand the total amount of what you are paying on a credit card or loan. It also serves as a basis for comparing financial products from different lenders and making more informed decisions.