What is APR and how is it different from APY and interest rates? These are all rates applied to your loan, but they show your rate in different ways.
Loans often come with loan agreements, loan terminology, and rates and fees. Annual Percentage Rate (APR) is a loan rate percentage used to help borrowers easily compare their loan options.
What Does APR Mean?
According to the Consumer Financial Protection Bureau (CFPB), the definition of Annual Percentage Rate (APR) is as follows:
"The Annual Percentage Rate (APR) is the cost you pay each year to borrow money, including fees, expressed as a percentage."
This rate includes the interest, fees, and other costs that can occur during the foreseeable life of a loan.
This number helps loan customers understand the overall costs and interest charged on a specific loan option.
Then, loan customers and credit card holders can compare the cost of borrowing between products more easily.
It’s important to note that APR is not the same as an interest rate.
An interest rate is the cost of borrowing, expressed as a percentage of the loan amount, without taking into account any fees or other charges.
APR on the other hand reflects the total cost of borrowing, including interest, fees, and other charges and works well as an overall comparison number between different loan options.
APR vs APY
You want to understand APR vs APY, so you don't confuse them together. APY stands for Annual Percentage Yield.
It can also be referred to as the Effective Annual Rate (EAR). It serves as a more accurate representation of the true rate of return on an investment or savings account, since it reflects the fact that interest earned on an investment or savings account is added to the account balance, and then earns interest in the following period.
By contrast, the APR is simply the interest rate that is applied to the principal balance of an account, without taking into consideration the effect of compound.
Types of APR
Annual rates can be implemented in a variety of ways. Because of this, it is important to understand what type of rate is being applied to your loan or credit card.
When a rate is described as variable, that means that the rates change over time.
This can be a benefit because the rate could lower later, but it could also get higher. Whether they rise or lower usually depends on what the general rates are doing in the area.
It 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 rate might increase.
With a fixed rate, 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.
They are beneficial because they won't get higher one day, but they also don't get a chance to lower your rate later either.
Sometimes, your loan or credit card will have different rates for different transactions.
For instance, you could have a different rate for only a certain period of time, applied during a balance transfer, or when you take out a cash advance.
Most often, multiple annual percentage rates are used for credit cards.
Purchase rates are the interest rate used on credit cards. When you carry a balance on a credit card, this is the interest rate on that balance.
How to Calculate APR
Once you understand the APR definition, you can start using it to help calculate things like total loan amounts, prime rates vs subprime rates, monthly payments, and other loan terms.
You may have questions like what is a good APR for a car, or what is a good APR for a credit card? By learning how to calculate APRs you can compare these rates yourself.
Daily Rates Formula
All you have to do is divide the percentage by the 365 days in the year. So, if your loan has a 10% rate, 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%.