APR is a nice little acronym that stands for “annual percentage rate.” You may have heard this term when applying for a credit card, personal loan, auto loan or mortgage. Understanding what APR is and why it’s important can help you look out for better deals when borrowing money.
Why Does APR Matter and Why Should I Care?
When you’re juggling work, family and other responsibilities, you might not want to invest extra time learning about another boring acronym. We get it. However, APR can have a dramatic impact on your financial health. Simply put, APR is the amount you pay to borrow money. By not understanding APR, you can pay a lot of interest on consumer loans and other debt that you might not even be aware of. Even a small adjustment in APR can have a significant impact on the amount you pay.
APR vs. Interest Rate
Many people think that “APR” and “interest rate” are interchangeable. But they’re not. The interest rate simply refers to the amount of interest you pay, given as a percentage, such as 10%. The APR includes the interest rate, but it also includes any other costs associated with borrowing the money. All of the fees are added to the interest rate and rolled into one figure and expressed on an annual basis. Because the APR represents the true cost of borrowing money, this is the most important figure to look at when considering different options for credit.
The APR may include fees such as:
- Administration fees
- Loan processing fees
- Underwriting fees
- Document preparation fees
Mortgages may include additional fees that are part of the APR, such as:
- Prepaid interest
- Brokers’ fees
- Escrow fees
- Closing costs
- Private mortgage insurance
How to Calculate APR
Now that you understand what an APR is, here comes the difficult math part. You add the total interest that is expected to be paid over the life of the loan by multiplying the interest rate by the principal and number of payments. Next, you add the fees to this figure. Then, you divide this figure by the amount of the loan and the number of days in the loan term. You multiply this by 365. Then, you multiply it by 100 to get the APR.
Yeah, that was a lot. Here it is in a mathematical formula:
[(Fees + Interest Paid Over Life of the Loan / Loan Amount)
/ (Number of Days in Loan Term) x 365] x 100 = APR
The APR is adjusted on a daily basis, taking into consideration the remaining amount of principle on the loan. Basically, the lower the APR, the better the deal.
Types of APR
If that wasn’t complicated enough, there may be different types of APR, such as:
- Purchase APR – This is the standard APR you pay for purchases on your credit card. Some cards offer an introductory purchase APR, which may give you a lower APR for the first few months or year after obtaining the account.
- Balance transfer APR – This is the APR you pay after transferring your balance on one credit card to another. This is usually lower than the regular APR.
- Cash advance APR – The cash advance APR is the amount you pay to get cash back from your card. This is usually higher.
Yes, if you read this and your head is spinning from all the math, you’re not alone. The math can look complicated, but at the end of the day, there are two major things to remember.
- APR and Interest are different things, always look for the APR on a loan or credit card to make sure there are sneaky fees
- The golden rule, always try and get your APR as low as possible
Thats it! See? Simple 😉