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.
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.
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 for 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 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.
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.
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%.
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.
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.
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 a "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.
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.
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