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What is APR and How Is It Used?

What is APR, and what does it mean for your loan? This acronym stands for Annual Percentage Rate and refers to the percent a borrower pays in interest and fees over the course of a year.

Loans often come with loan agreements, loan terminology, and rates and fees. APR is a common loan rate used so that loan borrowers can more easily compare loan options. If you're getting a loan, it's important to understand how this annual rate works to understand better how loan interest works. 

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What Does APR Mean? 

What is apr definition

Annual Percentage Rate (APR) is the fees and extra costs of a loan expressed as a percentage over the span of one year. This number helps loan customers understand the overall added 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.

Example of APR

When trying to understand complex loan terms, it helps to have an example. Say you want to borrow $100, and the lender or credit card charges a 10% annual percentage rate. Multiply $100 by 0.10 (10%) to calculate how much you will pay. In this example, you will pay $10 in interest and fees. 

The Purpose of APR

papers with money sign and percentage next to it

There are many 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 an annual percentage rate can help simplify the overall costs of different loan options. 

This annual rate shows an overall percentage of how much you would pay in additional fees to borrow during a full year. But there are reasons not only to consider this metric 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, you might not pay the full year’s worth of extra fees in what monthly payments you do have. 

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 or extend your loan term to make smaller payments. Refinancing will then affect how much interest you end up paying. 

APR vs Interest Rate 

apr vs interest rate

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 annual percentage rate is a higher number than the interest rate and works well as an overall comparison number between loan options. 

APR vs APY 

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 an annual rate 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 interest affects your loan. APY takes this into account. 

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. 

variable apr

Variable APR 

When a rate is described as a variable APR, 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. 

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 rate might increase. 

fixed apr

Fixed APR

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 rate later either. 

multiple apr

Multiple APR

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 APRs are used for credit card APRs.

How to Calculate APR 

If you want to figure out how to calculate APR, you can use the following example to help calculate it. By calculating your APR into a daily rate, you can better understand how much a loan's APR will affect you. 

how to calculate apr

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 calculation example

In Conclusion, 

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. If you are interested in taking a loan out, Check City offers a variety of loans that may work for you.