Understanding Annual Percentage Rates
When comparing mortgages, credit cards or other loan offers, the term “annual percentage rate” appears just about everywhere: from credit card offers, to an application form, to your monthly statements.
Understanding this APR number is crucial when taking out a loan, as it’ll determine how much you could be paying throughout its term. Here, you’ll want clarity on how an APR gets calculated and what you should consider a good one.
Introducing Annual Percentage Rates
An annual percentage rate (APR) is what you’ll pay in interest on your loan annually – think auto loans, mortgages and credit cards. You’ll see it as a percentage, and it’ll include all costs and fees that come with the loan. Those will differ depending on the type of loan you’re taking out – check the fine print carefully to see what you could be paying.
In general, these are the fees make up an APR:
- Origination fees – Typically associated with mortgages and personal loans, these are fees to close on your loan
- Processing fees – Some lenders call an origination fee a processing fee, though there can be a bunch of items rolled into it (again, carefully check the fine print)
- Appraisal fees – These are usually for home loans, where an appraiser comes to determine the current value of your house
- Document fees – What you’ll need to pay for the lender to draw up documents for your loan
An APR can make it easier to compare loan rates since it tends to include all the fees associated with it. In other words, it’s a fairly quick and simple way to do comparison shopping for loans.
Interest Rate Vs. APR: What’s The Difference?
An interest rate doesn’t take into consideration any costs and fees associated with a loan, where the APR does.
If you’re basing your decision on which loan to pick purely on the interest rate, then it won’t be an accurate assessment. It’s better to look at the APR so you have a more comprehensive overview of what each loan could cost you.
What is a Good APR?
The truth is, a good APR looks different for everyone. That’s because it’ll depend on the type of loan or debt you’re taking on as well as other factors like your credit profile. Sure, the best APR is 0%, but those are typically introductory offers that don’t last long. Sometimes getting a good APR will require you to pay certain fees or a down payment, such as with an auto loan.
And have caution. Some lenders will advertise low APRs via mortgages, for example, only for you to find out that you’ll need to buy discount points to use them. Or you could have a high APR for your credit card, but you don't end up paying any interest because you paid off the entire balance by the end of the grace period.
How Do I Lower My APR?
Lowering your annual percentage rate will depend on your ability to become more creditworthy. This could mean raising your credit score by making a series of on-time payments on existing loans and not applying for new credit around the time you’re applying for other loans.
Lenders will also look at other factors, like your income and other debts you have, to see whether you can take on more. That’s why many experts recommend checking your credit report so you can see what will affect your ability to get the most competitive rates. If there are errors on your credit report, make sure to take steps to correct it.
Another way to lower your rate is by paying extra fees. For example, to lower your mortgage APR, you can buy discount points from your lender. Think of these points as prepaid interest fees that will decrease the overall interest you’ll pay throughout the lifetime of your loan.
Whatever method you use to lower your APR, you’ll want to read the fine print to make sure you know what you’re getting into before taking on a new loan.
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