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Annual percentage rate, abbreviated as APR, is the approximate cost you have to pay out of pocket to borrow money through the use of a loan or credit card. Often, the APR also includes additional borrowing fees with simple interest.
Different APR rates usually sway borrowers in their decision-making. For instance, if a banking institution offers a 20% APR rate but a credit union offers a 10% APR rate, the borrower will choose the credit union to save money.
What Is APR?
APR is more commonly applied to a borrower’s debt amount: auto loans, personal loans, mortgages, and credit cards. But sometimes, an annual percentage rate can also show investors how much they’ll make on their return of purchase. It all depends on what you’re looking for – to borrow or to invest.
Generally speaking, the APR is referred to as how much money you’ll spend yearly to borrow X amount of money. It’s a very important figure when deciding where to borrow or invest money. I recommend doing thorough research before dedicating yourself to a specific APR at a financial location, as one branch may offer better rates than another. Compare and contrast to find the best option for you.
How Does APR Work?
When referring to a loan, APR almost always includes the yearly interest rate and any lender fees applied. That can include things like origination, legal, or underwriting fees, depending on the financial institution and their guidelines.
APR only refers to the annual percentage rate when referring to a credit card – no hidden fees are included.
Ideally, the reason behind creating the APR in finance was to educate borrowers and investors, to make sure they knew the out-of-pocket expenses on a loan or credit card and return value on savings. Luckily, the APR is not a hidden rate; it’s out in the open for everyone to see and choose according to their financial needs.
Types of Annual Percentage Rates
There are five basic APR rates that you should familiarize yourself with when looking to borrow or invest.
A purchase APR concerns itself with a purchase made via a credit card. Credit card companies often use a low APR or a 0% APR to draw customers in. After a year, that policy typically changes, and the APR rises exponentially.
A balance transfer APR concerns itself with the current debt you’re choosing to transfer onto a credit card. Credit card companies try their best to offer low balance transfer APRs for the first year to draw customers in, too.
A cash advance APR concerns itself with the number of cash backs you request via a credit card. In other words, if you ask for cash back when using your credit card, the APR on that cash back retrieval will usually be different from the typical purchase APR. Often, it’s a much higher rate to withdraw cash funds.
A penalty APR concerns itself with late or missed payments. This APR may not take effect the first few times you are late on a payment. After a few instances, though, the penalty APR can affect your account.
An introductory or promotional APR concerns itself with a limited-time offer on purchases. For example, if you’re new to the credit card company, they may want to get you on their side by offering 12-18 months with no interest or fees charged.
Outside of the types of APRs, you’ll find that an annual percentage rate can be fixed. This means that if you have a loan through a financial institution, that APR will stay the same throughout the loan period. If you have a 10% APR, it will never rise or become less than it already is. You’ll know the entire time how much money you’re expected to pay in interest by the time the loan term is up.
You may also choose to go with a financial institution’s APR that does not hold a fixed rate. In that case, you’ll choose the only other option – the variable rate.
A variable rate is not steady and will fluctuate over the loan term. Often, it starts at a low APR, but over time, it can change. You may end up paying less in interest and fees with a variable rate by the end of the loan term, but you also may end up paying more.
How Does APR Affect Credit Cards?
If you have a balance on your credit card at the end of each month, you’ll automatically be charged the APR your account has on those revolving purchases.
It gets a little tricky, understanding this area of APR. For example, if you make 10 purchases this month and you pay off all of those purchases, you won’t have to pay APR interest and fees. But, if you make 10 purchases this month, and you only pay off 5 of them, you will have to pay APR interest and fees on those other 5 purchases until they are paid off.
How Does APR Affect Loans?
Every time a loan is granted to a borrower, fees accompany said loan. Such fees include origination, broker, and private mortgage insurance fees. Sometimes, those fees are paid upfront. Other times, those fees are factored into the APR and you’re responsible for paying them over the course of your loan term. Speak with your financial institution if you have any further questions.
What Does 0% APR Mean?
When a financial institution or credit card company states that they are offering 0% APR for a limited amount of time, that means that there is no interest and there are no fees associated with the amount of money being borrowed. You won’t get this offer for an extended period of time. Most lenders will max this opportunity out at 18 months, depending on the loan amount and loan term.
Bottom Line: What Is APR?
To sum up, APR helps you determine how much money you’ll be charged to borrow a certain sum. With loans, the APR will include the simple interest and any associated fees. With credit cards, the APR will only concern itself with simple interest. It’s very important to know, understand, and choose wisely which APR is best for you.