An APR, or an annual percentage rate, is the amount you’ll pay to borrow money, expressed as an annualized percentage. When you borrow money with a loan or credit card, for example, your APR is what you’ll pay to borrow that money.
Is APR the same thing as your interest rate?
Not exactly. Your interest rate is the percentage of the principal that you’re charged on a monthly basis for borrowing money. If the interest rate on your car loan is 5 percent and you owe $10,000 on the loan, you’ll be charged 5 percent of $10,000, or $500, over the course of a year.
But your APR is the interest rate along with any additional fees that you may be required to pay in order to borrow the money. For instance, you may have to pay an origination fee to take out a loan for your car or house, or you may have to pay an additional fee to transfer a balance or get a cash advance on your credit card. The APR converts those fees into an annualized cost to show you the total cost of borrowing money.
While lenders often advertise their interest rates, that isn’t the only cost you’ll pay as a borrower. By determining APR, you can get a better understanding of what you’ll pay to borrow money. You can determine the APR of a loan or credit card by using an online APR calculator.
Does APR always stay the same?
Not necessarily. APR can be fixed, which means it stays the same throughout the life of the loan. A fixed APR can be helpful in budgeting because you’ll always know the amount you’ll be expected to pay each month.
But your APR may also be variable, which means it can fluctuate based on a financial index. When the index goes up, your APR will increase. And when the index goes down, your APR will decrease.
With a variable APR, you may be able to get a lower rate upfront, which can save you some money on the front end of your loan. But your payments could increase as the associated index increases—so you’ll have to be prepared for that.
How are interest rates determined?
Your interest rate for a credit card or a loan is set based on the current market rates, along with your credit score. If you have a high credit score, your interest rate will be lower.
However, your APR is set by the lender rather than the market. The lender determines the fees and other costs they will charge to lend you money. Some lenders may lower their fees for borrowers with higher credit scores, so a strong credit score may help you achieve a lower APR.
So should you compare interest rates or APRs?
If you’re shopping around for a new loan or a credit card, it’s a good idea to look at both numbers. In general, APR provides a truer cost of what you’ll pay to borrow money. But APR can also be tricky to determine—and it matters more with certain types of loans.
For example, with some types of borrowing money, APR and interest rate are basically the same. For most credit cards, your interest rate is your APR for most purchases. However, many credit cards have different APRs for different types of borrowing. Your APR for a cash advance or a balance transfer, for example, may be higher than your APR for purchases.
If you’re getting a mortgage loan, however, your APR will be quite different from your interest rate. Say you borrow $100,000 with an interest rate of 5 percent. Your annualized interest payment will be $5,000 per year. But to get that rate, you may be charged discount points, or extra fees, of 1.5 percent, an additional $1,500. You’ll also incur a mortgage loan origination fee of say, 1 percent, which is an additional $1,000. Your lender is also likely to charge additional fees and closing costs.
When all these fees are added, your monthly payment—and the amount you pay to borrow the money—will be higher than a simple 5 percent interest. And APR can show you exactly what those costs will be, on a monthly basis and throughout the life of the loan.
Basically, for loans with a set term, such as a 30-year mortgage or a three-year car loan, the APR can show you exactly what you’ll pay over the entire loan term.
How can you find out the APR of a credit product?
The Federal Truth in Lending Act requires lenders to disclose the APR of every consumer loan. Before you sign your name to borrow any money, be sure to read the Truth in Lending Disclosure, which may be included as part of the loan contract or as a separate document.
The Truth in Lending Disclosure will include your APR as well as finance charges you’ll pay if you make payments when due, the amount you’re borrowing, and the total amount of all the payments you’ll pay if you complete all the payments in the loan term.