An annual percentage rate, or APR, helps you determine the cost of different types of financing so you can compare your options even if the terms vary. You’ll see APRs advertised for loans, credit cards, and lines of credit.
Understanding how APRs work not only helps you choose the best financing option for your situation, it also helps clarify the true cost of credit. Find out what expenses are included in the APR and how they work specific products like credit cards, mortgages, and other types of loans.
APR Explained
The annual percentage rate of any kind of financing shows you the overall cost for a one-year period. It includes both the interest rate you’re offered as well as any fees that come along with it. These can vary greatly depending on if you’re applying for a credit card or a loan. At a basic level, you can multiply the APR by the borrowed amount to determine how much you’ll pay in interest and fees over the course of the year.
There are, of course, some variables that make this calculation a little less straightforward. But at a minimum, you can look at the APR to see which financing option could cost you the least amount of money over the year.
Credit Card APRs
Credit cards advertise an APR, but they actually charge a daily interest rate, not an annual one. As a result, the APR may be a little skewed if you’re hoping to find the exact cost of making charges on your card. In addition to your interest rate, the credit card APR also includes any fees, such as an annual fee. Some cards may waive the fee during your first year as a cardholder.
You can avoid your credit card APR altogether by not carrying a balance. If you start the month with a zero balance, you won’t be charged interest until after the next billing due date, assuming you didn’t pay in full. When you carry a balance on your credit card, interest is immediately charged on new purchases you make throughout your billing cycle.
There are also a few other factors that could impact your credit card APR, including introductory offers, variable APRs, and tiered APRs. Familiarize yourself with each one to potentially take advantage of some while keeping an eye out for less beneficial ones.
Introductory 0% APR on Credit Cards
When searching for the best credit card offers available, you may stumble upon some that offer an introductory 0% APR. This can be a great way to finance an expensive purchase without paying interest on it, but there are some things you need to be aware of before you proceed.
First, check the length of the 0% APR. It could be anywhere from a few months to as long as a year and a half. The credit card company should advertise what the standard APR range is once the introductory period is over.
Next, take a look at what is eligible for the promotional 0% APR. Some cards may only apply it to new purchases, while others may let you transfer balances from other credit cards and pay it down at the 0% rate. If you go this route, however, check the fine print for a balance transfer fee, which could charge a percentage of the transferred balance and add it to your overall balance on the new card.
Variable APRs on Credit Cards
You’ll notice that most credit cards advertise a variable APR, which means it can change based on certain circumstances. All variable ARPs are based on the prime rate, which is a base rate that can fluctuate over time. The APR you receive when you apply for the card is shown as one specific number, but it’s actually calculated by adding a set percentage to the prime rate. So if your variable APR is based on the prime rate + 15% and the prime rate jumps from 3% to 5%, you’ll see a 2% increase on your credit card APR
Another time your APR might increase is when you miss a payment on your credit card. In this situation, you can be charged a penalty rate. This automatically bumps up your APR to a higher interest rate for a set period of time. In most cases, the penalty rate only applies to new purchases moving forward, not your existing balance. The penalty usually ends after six months, but check your card agreement for your individual terms.
You may also see an increase in your credit card APR if your credit score has dropped significantly. Credit card companies periodically review each customer’s credit information. If they feel your new score warrants an APR raise, they should send you a notice at least 45 days before the increase takes place.
Tiered APRs
In addition to being charged a variable APR in certain circumstances, your credit card probably comes with a couple of different tiered rates as well. The advertised APR you receive with your card typically only applies to new purchases. You’ll likely receive a different rate on any balance transfer you initiate. Check out that specific APR before you decided to bring a balance from another credit card or loan because it’s likely higher than your purchase APR.
The other tier of APR you might see on your credit card is for cash advances. You can usually use your card to take cash out of an ATM, but you’ll pay interest at a might higher rate. Also, don’t forget about any ATM fees if you’re not in-network.
One major downside of using your credit card to take out cash is that you’ll be charged interest right away, rather than getting a grace period until your statement is due. The credit card company will also probably charge you a cash advance fee on top of the interest rate. It’s usually the higher of either $10 per transaction or 5% of the cash amount. Check your card agreement for details before getting a cash advance because it can end up being a costly decision.
Loan APRs
There are a few key differences when it comes to APRs on loans rather than credit cards. Most loans usually come with a fixed interest rate, although you might find some loans with variable rates, such as student loans and some mortgages. Unlike credit cards, however, you may be charged additional administrative fees by the lender.
The most common fee Includes an origination fee, which can range anywhere between 1% and 6% of the total loan amount and is deducted before you even receive the loan funds. Consequently, two seemingly identical loan offers for $10,000 with an 8% interest rate could actually be quite different if one lender charges a 2% origination fee and the other one charges a 6% origination fee.
With the first offer, you’d only have $200 deducted upfront, while the second offer would cost you $600. The APR includes the cost of the origination fee in addition to the interest rate over the course of 12 months.
Mortgage APRs
APRs for a mortgage operates a little differently than those for a personal loan. In addition to a loan processing fee, a mortgage APR also includes other closing costs and lender-related expenses such as mortgage insurance, underwriting fees, discount points, and any escrow fees. A home loan APR doesn’t include non-lender fees, such as the appraisal fee, attorney and notary fees, recording fee, and transfer taxes.
Most mortgages come with fixed-rate APRs but it’s also possible to get an adjustable-rate mortgage (ARM). That means your interest rate changes after a certain period of time. When browsing ARM options, you’ll see two numbers.
The first is the initial fixed-rate period in years and the second is how frequently (in years) the rate adjusts after the fixed period ends. For example, a 5/1 ARM would have a fixed rate for the first five years, then adjust based on the prime rate every year after that.
Other Factors Impacting Your APR
No matter what type of financing you seek, from a credit card to a loan, your APR is determined using a wide range of criteria. And as you’ve learned, it also has the potential to change in some situations.
But when you’re first applying for credit, lenders and credit card companies generally look at these three factors when making you an offer of credit.
- Credit Score: A strong credit score can land you a lower APR, saving you money as you repay your borrowed funds.
- Employment and Income: Particularly important on loan applications, creditors want to see that your income is stable and that you’ve been in your position or industry for at least two years.
- Debt-to-Income Ratio: No matter how much you earn, you should have an appropriate amount of debt that isn’t excessive for your income. If this ratio is off-balance, your APR could be higher — or you might not get approved at all.
