APR Definition: APR stands for Annual Percentage Rate and refers to the percent a loan customer or credit card holder will pay in interest and fees over the course of a year.
Explore this Vocabulary Guide:
- What Does APR Mean?
- Example of APR
- The Purpose of APR
- APR Calculator
- APR vs Interest Rate
- APR vs APY
- What Does APR Mean on a Credit Card?
- What Does APR Mean for Cars?
- What Does APR Mean for Mortgages?
- Variable APR
- Fixed APR
- Multiple APR
- 0% APR
What Does APR Mean?
Annual Percentage Rate (otherwise known as APR) is a percentage of all the fees and extra costs of a loan over the span of one year. This number helps loan customers understand the overall added costs of a specific loan option so they can more easily compare rates between different lenders.
Example of APR
In order to truly understand what APR means it helps to have an example. Say you want to borrow $100 and the lender or credit card charges a 10% APR. To figure out how much you’ll actually end up paying, you’ll want to multiply $100 by 0.10 (10%). You’ll end up paying $10 in interest and fees.
The Purpose of APR
There are a lot of different kinds of rates and terms that go into taking out a loan and it can all get confusing to add up. This is where APR can help simplify the overall costs of different loan options.
APR shows an overall percentage of how much you would pay in additional fees to borrow during a full year.
But there are reasons to not only consider APR when shopping for a loan:
You might not be borrowing for an entire year. You might only be borrowing for a few months or even a few weeks instead of a matter of years. If your loan term is shorter than a year then you might not end up paying the full APR’s worth of extra fees.
You also might not pay interest rates and fees all at once. Instead, you might be charged interest on your loan throughout the life of the loan, which will affect how some fees get calculated and how and when you pay them. Many lenders will charge their interest a little here and a little there throughout the life of the loan rather than all at once.
You might refinance the loan. This rate also doesn’t consider that you might refinance the loan, which can also change this math. You might need to increase the amount of your loan at some point or extend your loan term in order to make smaller payments. Refinancing will then affect how much interest you end up paying.
If you want to figure out how to calculate APR, don’t worry, it’s actually really easy. By calculating your APR into a daily rate, you can better understand how much a loan’s APR will affect you.
All you have to do is divide the APR percentage by the 365 days in the year. So if your loan has a 10% APR, you will divide 0.10 by 365 to get 0.000274. Then you take this number and convert it back into a percentage by moving the decimal to the right 2 spaces. This means that the daily rate of the loan is 0.0274%.
APR vs Interest Rate
The interest rate is an extra percentage that a lender charges a borrower for the risk they take in letting you borrow. But the interest rate is its own fee and doesn’t account for any other fees or charges that might be involved in the loan.
APR accounts for the interest rate and any additional fees that might be involved. Because of this the APR is a higher number than the interest rate and works well as an overall comparison number between loan options.
APR vs APY
APY stands for Annual Percentage Yield. It can also be referred to as the Effective Annual Rate (EAR). It takes even more costs of a loan into account than APR since it also includes compound interest.
Compound interest refers to the way interest gets applied to the loan. For instance, some loans will “compound” or apply interest once a day, once a month, or once a week, depending on the lender. How interest gets applied will change how much that interest ends up affecting your loan. APY takes this into account.
What Does APR Mean on a Credit Card?
APRs are going to impact credit card holders differently from loan borrowers. For example, many credit cards will have multiple APRs that change depending on the transaction. When you use your credit card to take out cash you might have a different APR applied to that transaction then if you were using those credit card funds to make a purchase.
Credit cards with a 0% APR will often have restrictions on what you can and can’t do with your credit card funds. For instance, you might not be allowed to borrow on a 0% APR card for longer than a few months before an APR will be applied.
We also sometimes use credit cards differently than we use loans. Loans are for larger one time purchases, but credit cards are often used more gradually and for longer periods of time. Credit cards can also come with perks that might make higher APRs worth it. APR might also not affect your credit card usage as much as it would a loan if you are good about paying off your credit card bills each month before they can accumulate much interest, if any.
What Does APR Mean for Cars?
APR will also have specific pros and cons when taking out a car loan. Title loans are when a borrower uses their car as collateral to borrow a loan, while an auto loan is used to purchase a vehicle. Either loan will be paid in installments for a matter of months or years and can often include APR penalties for missed or late payments.
On average, auto loan rates in the US are around 5.27% for a 60 to 80 month loan term. But many car loans end up being for longer than 60 months, creating higher and higher APRs. Lower credit scores and the condition of the car can also be factors in increasing the APR on a car loan.
What Does APR Mean for Mortgages?
One of the key features of APR is that it includes the interest rate and any other fees or charges tied to the loan. This is especially relevant with mortgages, or home loans. When purchasing a home, there are many costs involved. Your mortgage will include many of these extra costs and this additional loan cost will be reflected in your mortgage’s APR. Some of these extra mortgage costs include payments to the real estate broker, origination charges, inspection fees, and closing costs.
Different Kinds of APR
APR can be implemented in a variety of ways. Because of this, it is important to understand what type of APR is being applied to your loan or credit card.
When an APR is described as “variable” that means that the APR rates change over time. This can be a benefit because the APR could lower later, but it could also get higher. Whether they rise or lower usually depends on what the general APR rates are doing in the area.
Variable APRs can also rise due to a penalty. So if you fail to make a payment on time or if you default on the loan your variable APR might increase.
When an APR is fixed a borrower will know all the logistics of your loan upfront. The rates don’t change over time or fluctuate with the market. Instead, borrowers receive a set rate when they first start the loan and that percentage stays the same for the life of the loan.
Fixed APRs are beneficial because they won’t get higher one day, but they also don’t get a chance to lower your APR later either.
Sometimes your loan or credit card will have different APRs for different transactions. For instance, you could have a different APR applied when you transfer a balance and a different one applied when you take out a cash advance. Most often, multiple APRs are used for credit cards.
A 0% APR means that the amount you borrow isn’t being charged an interest rate. But for most loans, a 0% APR doesn’t last forever.
Many lenders who advertise a 0% APR have many restrictions and caveats surrounding that 0% APR that they aren’t telling you. They might have higher fees elsewhere in their application process, or the 0% APR is only for a certain amount of time or for up to a certain monetary amount. For example, a credit card featuring a 0% APR might only apply for the first 15 to 18 months and then the APR changes.
A 0% APR means that you pay no interest on new purchases and/or balance transfers for a certain period of time. The best 0% APR credit cards give 15-18 months without interest. But the average 0% APR intro period is about 10.5 months for cards offering 0% purchases.
Why It’s Important to Understand APR
If you are shopping for a loan near you or looking to apply for a new credit card, it’s important you understand what APR is and how it applies to you. Once you understand what APR is, you can better utilize APR rates to understand which loans and credit cards are the best options for you.
All loan and credit card shoppers should gain a thorough understanding of APR before they apply for a new loan or credit card.