What is APR, and how does it help you compare loans and credit cards? Well, APR (annual percentage rate) represents the fees and interest you’ll pay on a financial product over a period of one year.
APR is a more inclusive measure than interest rate alone, since it includes fees and any discounts. It’s useful because it allows you to compare different financial products on an apples-to-apples basis.
By comparing one APR with another, you can see which loan or line of credit has the lower cost of borrowing. Let’s now take a closer look at:
What is APR?
APR refers to the amount of interest and fees you’ll pay on a loan or credit card balance over the course of a year. APRs can look similar to interest rates, since both are expressed as a percentage of the principal balance.
Plus, both APRs and interest rates can be fixed or variable, meaning they can either stay the same or fluctuate over the life of your loan.
APR vs. interest rate: Know the difference
When it comes to comparing APR versus interest rate, APR is a more inclusive term.
APR includes extra fees (or discounts) along with interest. For instance, a personal loan might have an origination fee, or a mortgage could come with closing costs. When it comes to the costs of borrowing, APR, rather than interest rate, shows you the whole picture.
Plus, all lenders must disclose APR on their loans and credit cards by law, according to the Truth in Lending Act of 1968. This act protects consumers by requiring lenders to disclose the true costs of borrowing.
Thanks to this law, you can compare loans and mortgages at a glance and get a clear picture of their long-term costs. Then again, if you do run across a product that lists the interest rate and fees separately, you can use this calculator to convert it to APR.
Interest rate vs. APR calculator
Now that we’ve looked at what APR is, let’s review some of the key details about this common financial measure:
Loans and mortgages typically have a single APR, and it’s expressed as a percentage of the principal.
For example, let’s say you’re looking to take out a $200,000 mortgage. The interest rate on the mortgage is 4.50%, but the APR is 4.7035% as a result of $4,800 in closing costs. With a 30-year mortgage, you’d end up paying $173,569.40 in interest and fees.
For comparison’s sake, let’s say another lender offers you the same mortgage with a 4.00% interest rate (4.198% APR). After 30 years, you’d pay $152,008.55 in interest and fees. By lowering your APR about half of a percentage point, you’d save more than $21,500.
As you can see, this chance to compare offers (and APRs) helps you make the best choice for your budget. You’ll get a complete sense of the costs of borrowing.
Unlike loans and mortgages, credit cards often have different APRs for different transactions. You might have a different APR for purchases, balance transfers and cash advances.
One brand-name credit card we looked at — we’ll leave the name out, since we’re just using it as an example — starts with a 0% Intro APR for 15 months on purchases and balance transfers. Then a 14.99% to 23.74% variable APR applies. (Keep in mind: Credit cards have some of the highest APRs of any financial product.)
That being said, credit card APR might never come into play. If you pay your balance off in full every month, you’ll never pay interest or late fees. As a result, your credit APR can effectively be 0%.
If you never carry a balance on a credit card, you don’t have to worry too much about APR. But if you miss a bill, you can see how these high APRs can make paying off credit card debt difficult.
When lenders advertise their products, they usually state a range of APRs. SoFi, for example, offers personal loans with fixed APRs between 5.99% and 20.69%. As of the writing of this post, that range is well below the credit card example’s APR of 14.99%-23.74% cited above.
So what does APR mean when it’s expressed as a range? Well, part of your APR depends on an index, like the Prime Rate. For instance, that credit card issuer used as an example above bases its APR on the Prime Rate (which was 3.25%, as of March 16, 2020) — but then it adds 11.74 to 20.49 percentage points to it, depending on your creditworthiness.
Ultimately, the rate you get on a credit card or loan depends on your credit score and history of repayment. Lenders assess your financial background before offering you an APR. The stronger your credit, the lower your rate will be. If you have poor credit, you might end up with a high APR on a loan or credit card.
Still, every lender does things a little differently. So, if you’re looking to borrow money or take out a line of credit, it can be a good idea to shop around to find your best rate.
Along with APR, you might also have come across the term APY, or annual percentage yield. APY is commonly seen on savings account products, and you might consider the APY on two savings accounts to determine which will grow your money faster. When referring to savings accounts, APY tells you how much money you could make.
On loan products, however, APY tells you how much your loan will cost, similar to an APR. But where APR reflects interest and fees on an annual basis, APY takes compounding interest into account to give you an even more accurate look at your total charges.
The more frequently interest compounds, the more you’ll end up paying in the long run — so, you’d pay more for a loan where interest compounds daily than for one that compounds monthly.
If you want to take a microscope to the charges behind a loan or credit card, consider the APY. Otherwise, you should be fine sticking with APR when you compare loan products.
Now that you’re an expert in answering the question, “What is APR?” you can use this knowledge to compare loans, mortgages and credit cards.
Instead of getting caught up in the weeds of different fee structures, you can rely on APR to compare multiple products. Just remember: By choosing the loan with the lowest APR, you’ll save money on interest.
The information above has been independently collected by Student Loan Hero and has not been reviewed or provided by any third party.