What Is APR and How Does It Work?
APR means annual percentage rate, a standardized measure of how much interest you will pay throughout the year plus any applicable loan fees. This is expressed as a percentage of your principal loan amount. In short, the APR is what a lender charges you for borrowing money.
APR is used by credit card companies and lenders of all kinds and is useful for comparing offers from different creditors.
How does APR work?
When you apply for loans or credit products, the APR is one of the pieces of information you’ll use to make a decision.
“APR […] is designed to help you understand the impact of fees on your cost environment,” explains Matt Carter, a personal finance expert with Credible, an online loan marketplace.
There are two types of APR:
- Fixed rate. A fixed APR stays the same over the life of the loan, so you’ll always make the same monthly payment.
- Variable rate. A variable APR changes as the federal prime interest rate goes up or down. They can be very low during a recession but will spike up once the economy recovers.
A few factors affect the APR you’re likely to get:
- Your credit score. Your credit score tells lenders how likely it is you’ll make your payments on time. If you have a higher credit score, you’ll get a lower APR. Generally, a score above 670 is considered good credit.
- The loan term. A longer loan term usually means a higher APR for two reasons: one, there’s a greater chance interest rates will rise with time, and two, there’s a greater chance the borrower will default.
APR does not consider how your interest is compounded over time; for that, you need to look at the APY (annual percentage yield), which tells you how much interest you will pay throughout the year including the compounding interest.
When comparing APRs between lenders, keep in mind that the rates advertised by lenders and credit card issuers are usually for people with a Very Good (740+) credit score. Read the disclaimers!
Differences between APR and interest rate
While the terms “APR” and “interest rate” are often used interchangeably, they are not the same thing.
As we mentioned earlier, the annual percentage rate includes the interest rate and the fees you have to pay the bank to borrow the money.
The interest rate, on the other hand, is only one portion of the total cost of the loan.
So, all APRs include the interest rate, but not all interest rates are APRs.
This distinction is important because, when you’re comparing offers from different lenders, you should make sure to compare APRs to APRs and interest rates to interest rates.
|A percentage of the principal or what you pay for borrowing money||The total cost of the loan broken up over the length of the loan|
|Doesn’t reflect fees or charges||Includes all associated charges and fees|
|Determines your monthly payment||Makes it easier to compare the true cost of loans|
How APR affects your loans
When you take out a loan — whether it’s an auto loan, a personal loan, or a mortgage — you are responsible for paying fees to the bank.
Some you pay upfront when you take out the loan; others are included in your APR and you pay them over the years along with interest.
Some fees that may be included in your loan APR are:
- Origination fees. The cost charged by the bank for processing your loan application. Other administrative fees could be included in your closing costs.
- Mortgage broker fees. If you used a mortgage broker, their fees are usually 1% to 2% of your loan amount.
- Private mortgage insurance (PMI). You will be required to pay insurance if you have a conventional mortgage and made a down payment of less than 20%.
Check out the latest mortgage rates on our website and find the best mortgage lenders for your home purchase.
How APR affects your credit cards
If you look at your credit card terms, you’ll see a table — called a Schumer box — listing all APRs and fees associated with your card. It’s important for cardholders to understand these charges.
Some of the different types of APR on credit cards are:
- Purchase APR. The interest rate applied to the new purchases you make with your card. It can be fixed or variable, meaning it changes depending on the prime rate.
- Introductory APR. A promotional purchase APR offered temporarily which usually lasts between six and 18 months.
- Cash Advance APR. Applied to any money you withdraw as cash from your credit line. It’s also subject to additional fees added to your bill total.
- Balance Transfer APR. Applied to the balance you move from one credit card to another.
- Penalty APR. Applied to your balance if you make a late payment, if a payment bounces or if you exceed your credit limit.
Carrying a credit card balance from month to month means you’ll be charged APR and interest unless the credit card balance repayment is processed within the grace period, which is the period of time between the end of the billing cycle and the bill’s due date.
Visit our page on the best credit cards and best credit card deals.
APR by the numbers
Let’s compare two mortgage offers for a house valued at $160,000.
|Mortgage 1||Mortgage 2|
|Loan Term||30-year fixed||15-year fixed|
|Total paid at the end of the term||$245,960.53||$200,275.56|
A higher APR paired with a longer loan term does mean you’ll pay less month to month, but in this example, you’d pay $45,000 more in interest and fees over the life of the loan than if you had selected the shorter loan length.
You can use our mortgage calculator to model your own mortgage examples.
Now, let’s compare two credit cards with a balance of $10,000.
|Credit Card 1||Credit Card 2|
|Time to pay off the balance||43 months||58 months|
|Total interest paid||$4,106||$10,876|
As you can see, a higher credit card APR can add up considerably, especially if it takes you longer to pay off the card completely.
Summary of Money's guide to APR
- APR is the full cost of borrowing, including interest charges and any fees.
- APR and interest rate are not the same thing.
- You can use APR to compare loan or credit card offers on even footing.
- Your credit score is a huge factor in determining your APR
- Look closely at a loan’s APR and compare — you might be surprised what’s the better deal