APR – What is it and how Does it Work

According to CFPB (Consumer Financial Protection Bureau), the term APR you come across when applying for mortgages, car or personal loans means the annual percentage rate. 

APR- What it is

APR or annual percentage rate is the official rate at which you borrow. We can also describe it as the annual rate of interest the borrowers pay, and the investors receive.  In addition to the cost of borrowing in APR, it also includes other factors such as the interest rate, addition credit offer charges and several other things. 

You will always receive a percentage as the expression representing your annual funds cost over the life of your loan or the money you earn from investments. Whenever you apply for a loan, it is your lender’s duty to inform you of their APR before you can sign the agreement of credit with the institution. In a nutshell though, the APR only provides you with a bottom-line percentage so that you can compare it against the rates that other lenders are offering. 

APR – How it works

When we have to compare unsecured loans, short term loans and credit cards, we use APR for it. Lenders generally state it as a percentage to show what amount you are borrowing.  In it, you will see how much you will pay annually by taking note of things like monthly payments and others. 

However, you must note that APR shows you the yearly interest rate you pay on investments but it does not account for your interesting compounding within that year.

For instance, let us suppose that you are applying for a personal loan that has a 15% APR. You will find this loan cheaper than one having an APR of 17.5%. However, you can only gain a definite idea after reading the terms and conditions carefully. You must also note that your APR only takes stock of compulsory charges. It is most likely to exclude costs such as payment protection and fees etc. 

At the same time, APR does not fines on late payments or penalty of crossing your credit limit as well. It would not be incorrect to assume APR as a tool for estimating how much you have to borrow to pay every month.

In fact, if you’ve got credit cards, it is even more essential to look at the APR if you’ve got a balance pending from month to month. As a credit card owner, you’re surely aware of the grace period that card companies allow for new purchases. 

You generally don’t have to worry about interest charges if you meet your balance payments on time each month. In the case you do carry a balance from the previous month, you must note that interest charges will be in order for the unpaid portion, depending on your APR. 

APR – Its Importance

For most borrowers, APR is not an uncommon term. If you haven’t applied for a credit card, mortgage or car loan etc. you must have encountered this percentage frequently. 

The truth is that understanding your APR in detail aids you in making informed and wise credit decisions. When you are aware of how much you will have to pay if you want to borrow money, you’ll take better financial decisions. 

APR – What is a good one

The general rule of applying for loans is that the more one borrows, the lesser their APR will be. When talking about credit cards, it’s common to experience a range of 5% to 30% and even more. The APR that your lender will offer will largely depend on the status of your credit score. 

You probably are also aware of the interesting fact that APR rates generally depend on some other rates you have maintained, such as online and in-store purchases etc. However, the case is different for certain other transactions, such as withdrawals etc. 

Finally, the only situations where you experience 0% APR is in times of balance transfer and 0% purchase credit cards but that is only for a promotional period, such as from three to forty months. In fact, you can likely lose your promotional rate too if you fail to adhere to the terms and conditions or fail making payments in full and on time during the period. 

Additionally, the best approach is to pay off your card before your promotional period ends, otherwise you will have to then start paying according to the standard variable rate. 

In short, your credit score plays a huge role in determining a good rate for you.

APR – How to Calculate 

Lending companies generally use a calculation formula for the APR. It helps them determine the interest you pay on your existing or outstanding balance. Generally, the lenders calculate the APR on a monthly or even daily basis, as per the card in question. 

There also certain accounts where multiple APRs apply. It is the responsibility of the card issuers to tell you how they calculate the APRs in addition to determining your eligibility. You can determine this by checking terms and disclosures of the card you are applying for. 

Again, the type of loan also determines the cost of calculating an APR, which can vary by each loan. For instance, an auto loan several factors could determine the APR, such as age of the car, down payment, loan amount and credit history etc. For a mortgage, the APR could depend on the origination fees, points and interest rate. 

Types of APRs

Typically, you will get a variable APR or a fixed APR although there are several other types. Mentioned below, are some of the types:

#1 Cash Advance APR

If you plan to borrow cash from your credit card, note that the APR will be higher. You can very likely experience different APRs for cash advances or checks and most transactions do not offer a grace period. 

#2 Variable APR

A variable APR usually links to an index interest rate, like the prime rate for example. In this case, your variable APR will simultaneously increase too if your prime rate increases. So if you start off with the loan with a lower APR initially, you should expect the rate to increase as time progresses. 

That said, this feature means that you may have to struggle with your monthly budget plans in the future.

#3 Fixed Rate APR

If you’re looking for a stable budgeting, then a fixed APR works favorably. In this one, the APR typically remains the same over the life of the loan. Hence, when the rates are predictable, it becomes easy for one to plan the monthly budget. 

Final Thoughts

APR is typically just a factor when you have to choose a credit card but it is an essential one nonetheless. Understanding how an APR works, what it is and how your monthly payments will alter because of it allows you to make informed and stable decisions in the future.

Laura is a passionate, results-driven and self-motivated digital marketing professional. With a strong interest in SEO & copywriting, and a proven track record of content creation & optimisation.