APR: What It Is And How It’s Calculated
3-Minute ReadJune 06, 2022
When comparing mortgages, credit cards or other loan offers, the term “annual percentage rate” (APR) appears just about everywhere, including offer letters, application forms and monthly statements.
Understanding this APR number is crucial when taking out a loan, as it’ll determine how much you could pay throughout the loanterm. Let’s take a look at what goes into your APR and how it can affect your loans.
What Is APR?
APR is the percentage representing the yearly cost of borrowing money, whether in the form of a personal loan, car loan, mortgage loan or credit card. Unlike a simple interest rate, this percentage includes all costs and fees associated with the loan. These will differ depending on the type of loan you’re taking out, so check the fine print carefully to see what you could be paying.
Fixed Vs. Variable APR
Your loan or credit card may have fixed-rate or variable interest. With a fixed APR, your rate will stay the same throughout the life of the loan. Mortgages and personal loans will typically have a fixed APR. Variable APRs, most common in credit cards, are tied to an index interest rate, such as the prime rate, and can rise and fall according to the current rate.
APR Vs. APY
It’s possible to confuse APR with APY, which stands for annual percentage yield. Your APY represents your rate of return on an investment or savings deposit, whereas APR pertains more to loans. In short, your APY is interest you earn, and APR is interest you owe. APY also takes compound interest into account during its calculations.
How Does APR Work?
In general, these are the fees that make up an APR:
- Origination fees: Origination fees are essentially service fees a lender charges to close on your loan. These fees are typically associated with mortgages and personal loans.
- Processing fees: Some lenders call an origination fee a processing fee, though multiple items can be rolled into
- Appraisal fees: These are usually for home loans, where an appraiser comes to determine the value of your house.
- Document fees: These are what you’ll 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 a loan. In other words, it’s a fairly quick and simple way to do comparison shopping for loans.
What Is The Difference Between Interest Rate And APR?
An interest rate doesn’t take into consideration any costs and fees associated with a loan, where the APR does.
If interest rate is your deciding factor on the loan you choose, then you won’t make 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.
How To Calculate APR
Knowing how APR is calculated can be a big assist when you’re shopping for the right loan. Determining your own APR is relatively easy if you already know how much you’ll pay in fees and interest over the life of the loan. Follow these steps to find your APR:
- Add up your fees and interest.
- Divide the above sum by the loan amount, or principal.
- Divide your result by the number of days in your loan’s term.
- Multiply everything by 365 (the number of days in a year).
- Multiply the result by 100 to find your APR.
Types Of APRs
A credit card can have multiple APRs attached to it, depending on its usage. These APRs may include:
- Purchase APR: This is the rate you pay for purchases made with your card. You can avoid paying interest if you pay off the full balance within the grace period.
- Balance transfer APR: This is the interest you’ll pay on debt that you move from one card to another when doing a balance transfer.
- Cash advance APR: You pay a cash advance rate every time you withdraw money from an ATM. Cash advances typically carry higher rates than both purchase and balance transfer.
- Introductory APR: Some credit unions and card issuers will offer a promotional rate – as low as 0% – to new customers to encourage them to apply for a card. Your APR will increase after the introductory period ends.
- Penalty APR: A missed payment will trigger a rate increase. A penalty rate affects all balances on your card.
What Is A Good APR For A Credit Card?
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. Some loans may offer 0% APR, but these are typically introductory offers that usually only last 12 – 18 months. Sometimes getting a good APR will require you to pay certain fees or a down payment, such as with an auto loan.
It’s important, however, to proceed with caution. Some lenders and credit card issuers 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 owing any interest because you paid off the entire balance by the end of the grace period.
What Is The Average APR For A Personal Loan?
The rate a lender will offer you for a personal loan depends on multiple factors:
- Your age (those under 18 in the U.S. cannot get a loan without a co-signer)
- Your credit score and credit history
- Your income and employment status
- Whether the loan is secured or unsecured
As with most loans, a higher credit score can earn you a lower APR. The average rate for applicants with a score of 740 or higher is 12% – 14%.
Personal loans can offer better APRs than other sources, so if you think a personal loan is a good idea but have more questions about your specific situation, you can reach out to one of our Personal Loan Experts.
How To Lower Your APR
Lowering your annual percentage rate will depend on your ability to improve your credit score. This could mean making a series of on-time monthly payments on existing loans and waiting to apply for new credit.
Lenders will also look at other factors, like your income and other debts, to see whether you can afford to take on more. This is why many experts recommend checking your credit report so you can see what will affect your ability to get the most competitive rates. If your credit report has errors, make sure to take steps to correct them.
You can also lower your rate by paying extra fees. For example, to reduce your mortgage APR, you can buy discount points from your lender. Think of these points as prepaid interest fees that will decrease the interest you’ll pay throughout the life 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.
It can seem like a lot to keep track of at first, but knowing and understanding APR and what affects it can help you make well-informed decisions when comparing loans. If you understand everything involved with your APR calculator, you can better determine how much borrowing a loan will cost you.
Want to know the personal loan rates and terms you can qualify for? Get prequalified today with Rocket Loans℠.
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