What is annual percentage rate (APR)?

In a nutshell

The annual percentage rate (APR) of a loan represents the actual yearly cost of funds, including interest and fees.

• Credit cards, mortgages, personal loans, and lines of credit will have their interest rates expressed as an APR.
• An APR does not take into account compound interest.
• An APR includes both interest and fees, allowing you to make an apples-to-apples comparison between two loans with different terms and fee structures. If you apply for a loan, the lender must disclose the APR and other costs before you agree to the loan.

Knowing what an APR is and how it is calculated can help you understand the cost of borrowing money and guide you to make informed decisions about your use of credit.

How does APR work?

An APR is simply a way to express the total cost of a loan, including interest and fees.

On loans and lines of credit, your loan’s interest rate and fees will be assessed periodically on any outstanding balance of your loan until the loan is paid off. Your loan’s interest rate may differ from the loan’s APR if you pay origination, servicing, or other fees.

If you are using a credit card, your APR is frequently equal to your interest rate, but you might have different APRs assessed against your purchases, balance transfers, and cash advances based on your card’s terms and conditions. If you pay your credit card balance every month, you will have at least 21 days after your credit card statement date as a grace period to pay for charges without interest.

How to calculate APR

Most loan interest rates are expressed as an APR, which does not include a calculation of compound interest. Taking a look at how APR is calculated can help you understand the components of your loan’s cost that are included in your loan’s APR.

Here’s the formula:

$APR=(\left({{\frac{\frac {Fees + Interest} p}n}}\right)*365)*100$

• Fees are charges for services that a lender includes in its APR calculation.
• Interest includes all interest paid over the life of the loan.
• P (principal) is the initial balance of the loan.
• n is the number of days in the loan term.

While an APR calculation can include fees, banks have a lot of leeway on which fees they include in their APR calculations. If you are considering a loan, be sure to understand which fees are included in the APR.

Types of APRs

Most loans will charge a single APR, but revolving credit products like credit cards frequently allow balance transfers and cash advances in addition to purchases. Each of these types of transactions might carry its own APR. Here are some of the types of APRs you might encounter.

Purchase APR

A credit card’s purchase APR is the rate applied to purchases made with the card. If you pay off your credit card every month, you won’t be charged interest on your purchases if you pay your credit card within its grace period, which is usually 21 days or more after your statement closing date.

Balance transfer APR

Some credit cards offer the ability to move credit balances from other credit cards to your card. This type of transaction is called a balance transfer and often carries a separate balance transfer APR. A balance transfer APR is a rate applied only to balance transfers from other credit cards.

Introductory or promotional APR

An introductory APR is a limited-time promotional APR offered to entice new customers to sign up for a credit card. Introductory APRs can apply to purchases, balance transfers, cash advances, or some combination of those. Sometimes banks offer promotional APR offers to existing customers as well. After an introductory promotional APR expires, purchases, balance transfers, and cash advances will revert to their normal APRs.

Cash advance APR

Many credit card issuers offer the ability to borrow a limited amount of cash using your credit card via ATMs, checks, or directly at a bank. These transactions are charged a cash advance APR, which is typically higher than your purchase APR. There is no grace period on cash advances, so you’ll begin paying interest immediately when a transaction posts.

Penalty APR

If you fail to make payments on time or violate the terms of your credit card agreement, you may be charged a penalty APR, which is usually the highest APR that a credit card issuer can charge.

Fixed APR vs. variable APR

APRs can be either fixed or variable. A loan with a definite term, like a 30-year mortgage, might have a fixed APR, while a credit card or personal line of credit is likely to have a variable APR.

A loan with a fixed APR will have a set APR for the duration of the loan that does not fluctuate based on market conditions. You will most commonly find fixed APRs on definite-term loans like mortgages and personal loans.

Loans with variable interest rates have APRs that can change periodically, either resetting on a known schedule or floating with market rates. Loans with variable APRs are usually tied to a benchmark rate, such as the prime rate and calculate their interest rates by adding a set premium to the loan’s benchmark rate. Most credit cards, personal lines of credit, and other loans that do not have a fixed term will have variable interest rates, though variable-rate mortgages are commonly available as well.

Some variable interest rate loans offer a fixed APR for a certain period before resetting their APR based on market conditions. A 5/1 adjustable-rate mortgage (ARM), for example, has a fixed interest rate for the first five years of the loan and then adjusts its interest rate every year afterward.

APR vs. interest rate vs. APY

APR differs from interest rate because it includes both the interest charged on your loan principal and the fees you incur for originating and servicing a loan. It is meant to be a broad measure that captures the whole cost of borrowing money. In cases where there are no lender fees, the APR and interest rate are the same.

APY, or annual percentage yield, is usually quoted as an effective interest rate on money you save. If you have a checking account, savings account, or certificate of deposit, the interest rate you earn is quoted as an APY. Your APY will tell you how much interest you can expect to earn in a year, including compound interest.

How to get a lower APR on a credit card

The most important factor that influences what APR a bank will offer to you on a credit card is your credit score. Maintaining a strong credit score is essential if you want to secure a credit card offering a lower APR. A very good credit score of 750 or better will increase the chances that you will qualify for a lower APR.

Some banks offer promotional APRs to existing credit card holders. If you are looking for a lower interest rate, it can be worthwhile to check your account online or call your credit card issuer to see if a promotional interest rate is available.

Finally, many banks offer low-APR or 0% balance transfer promotions to new customers who are willing to open a credit card and transfer a balance. These balance transfer offers frequently come with a fee (typically around 3%), but the fee is likely much less than the interest charges you’ll save by transferring a balance.