Learn what APR is, how it is calculated, what factors impact it, and how to avoid credit card interest charges!
When looking at credit cards and loans, encountering the term APR (Annual Percentage Rate) is inevitable. But do you know what it means and how it impacts your finances? That is what we are going to talk about.
Understanding more about it is a fundamental step that will help you make informed borrowing decisions. Also, if you want to check out more financial tips on our website, you can click on this link!
What Is An APR?
In essence, it is a single percentage figure that reflects the total cost of borrowing money over a year. It encompasses not just the base interest rate, but also any additional fees associated with the loan, including origination fees, annual fees, and closing costs. So, while the base interest rate might seem like a good deal, the APR gives you a clearer picture of the actual cost you’ll pay for borrowing.
Imagine it as the “all-inclusive price tag” on a loan. The base interest rate is like the base price, but the APR factors in all the extras, ensuring you understand the complete financial commitment.
Types of APR
- Purchase APR: this rate applies to the purchases you make with your credit card;
- Balance Transfer APR: when you move a balance from one credit card to another, this is the APR that applies to that portion of your balance. It’s usually the same rate as the purchase one;
- Promotional or Introductory APR: some credit cards offer a low or 0% APR at the beginning to encourage you to open an account. This applies to purchases or balance transfers for a limited time;
- Cash Advance APR: if you withdraw cash from an ATM using your credit card, this one applies to the amount you withdraw. It’s typically higher than the purchase rate, and there’s no grace period;
- Penalty APR: if you’re more than 60 days late on payments, many credit card agreements impose a higher penalty APR;
- Fixed APR: stays constant for the duration of the loan. It’s common with installment loans but rare with credit cards;
- Variable APR: changes along with market interest rates, potentially increasing over time. It’s the most prevalent type for credit cards and is also available for some installment loans.
How Is APR Calculated?
While the exact formula might differ slightly depending on the lender and loan type, it can be calculated based on:
- Base Interest Rate: the lender’s advertised rate for the loan;
- Loan Fees: any upfront fees associated with the loan, such as origination fees, application fees, and points (a point typically equals 1% of the loan amount);
- Loan Term: the length of time you have to repay the loan (e.g., 12 months for a credit card, 36 months for a car loan, 30 years for a mortgage).
Important note: It’s crucial to remember that it is an annualized rate. So, if your loan term is less than a year (like a credit card balance), the actual interest you pay will be a fraction of the APR.
What Impacts It?
- Credit History: if your past borrowing behavior suggests you might struggle to repay debts, lenders might charge you a higher APR;
- Income: lenders check your debt-to-income ratio (how much of your income goes towards debt). If it’s high, they may either charge you more interest or reject your application because it seems you can’t handle more debt;
- Fees and Charges: sometimes, lenders add extra fees on top of interest, which boosts it;
- Prime Rate: this is a baseline interest rate banks use. It’s set by the Federal Reserve. Changes in this rate can affect what you’ll pay on new loans, but not on loans you already have, unless your APR is variable;
- Loan Type: some loans have lower APRs because they’re “secured” by something valuable, like a home or car. This reduces the risk for the lender. Other loans, like personal loans or credit cards, are riskier for lenders, so they come with higher ones;
- Loan Term: generally, longer loan terms come with higher APRs. This is because lenders are extending credit for a more extended period.