When you take out a credit card or apply for a loan, you may come across the term APR – or Annual Percentage Rate. APR helps borrowers understand the total cost of a loan or line of credit.
By understanding what APR is, you may be better prepared to determine whether an enticing credit card or loan is as good of a deal as it seems.
APR Explained
APR is the annual rate charged for borrowing money. APR is expressed in percentage form and depends on the type of loan or credit provided:
- Loans: Loans like mortgages come with an APR that describes how much (as a percentage) you’ll pay on top of your principal over the course of a year. This percentage can include items like any fees included with the loan on top of interest.
- Credit Cards: The APR for credit cards is an expression of the interest rate you pay if you have an outstanding balance.
APR is used for many different loans, and it differs in some ways by the loan. For example, the APR on a credit card is the interest rate you pay if you don’t pay off your whole balance that month. This doesn’t include other fees or charges, but still reflects the price of what the credit card company is loaning you.
How to Calculate APR
APR is calculated by using the monthly payment to determine interest and then by adding additional fees and expenses involved in the cost. If there are no extra fees on the loan, then the APR and the interest rate may be the same. This means that a low-interest loan could have a low APR because of minimal fees or a high APR because of the extra costs.
There are multiple online tools that you can turn to if you want to calculate APR. For example, the U.S. Securities and Exchange Commission has a Compound Interest Calculator and other analysis tools to help consumers make smart financial decisions.
The Different Types of APR
There are various types of APR that you may encounter in your research:
- The purchase APR is the standard APR added to credit card purchases. This is one of the most common APR types that you will see.
- A penalty APR is added when borrowers violate loan terms – often by missing payments.
- A cash advance APR is set for people who borrow cash from their credit cards through an ATM or bank withdrawal. These may be different from your standard credit card APR.
- An introductory APR or promotional APR is a lower rate in the short-term to bring in customers. The APR then increases once the promotional period ends. Some companies offer a 0% APR rate in the short term to bring in more customers.
- A balance transfer APR is a lower APR rate on purchases that you transfer over from another credit card. This is another promotional strategy to gain new customers through a better APR rate than their existing credit cards.
There are also two different forms of APR for credit cards, each offered depending on the creditor:
- Fixed APR is an APR rate that is fixed when you are granted a line of credit, and will only typically change after the company announces a change to you beforehand.
- Variable APR is an APR rate that fluctuates with an indexed interest rate (usually outlined in the cardholder agreement).
Factors That Influence APR
APR calculation is based on the policies of the lender. Lenders will often look at several individual factors before offering an APR rate. These include:
- Loan terms and size: larger loans are often riskier and may have a higher APR.
- Current debt: this is based on the type of debt you have and how you are working to pay it off.
- Annual income: some lenders believe that people who earn more may be able to pay off a loan faster or may be less likely to miss payments.
- Credit score: higher credit scores may lead to lower APR offers (and vice versa). This is because the borrower has a proven history of paying off debts.
- Employment history: stable employment often means stable income, increasing the chances that the loan will be paid on time and decreasing the risk to lenders.
As you can see, there are some APR factors that are more in your control over others.
What Is Considered Good APR?
APR is so personalized and based on the type of loan that it is hard to list a good APR level. Especially because most people only qualify for a good APR if they also have good credit. APR rates vary by the type of loan you are looking for (or credit card you are applying for) and your credit history.
One option for borrowers is to shop around when looking for a loan. Comparing APR rates across many banks or credit card providers may give you a better idea of what lenders are willing to offer you.
In Closing
Whenever you take out a loan or a credit card, you are likely to come across the annual percentage rate. This determines how much you will pay more so than the interest rate offered. Knowing what a good APR is may be able to help you determine whether a loan or credit card offer is in your best interest.
