APR is the acronym for “annual percentage rate.” That percentage represents the total annual cost you pay for borrowing money, typically for auto, mortgage, or credit card loans. The APR includes the interest rate amount and any other fees you pay for a loan. APR rates can vary due to several factors.
Learn the difference between APR vs. fixed interest rate loans, how APR works, etc. Knowing more can help you make better decisions when you sign for a loan in the future and knowing what it costs to carry a loan balance.
How Does APR Work?
Annual percentage rates are applied to balances on a loan, such as a credit card. APR is a percentage that is determined using a complex math calculation. APR information is found on Loan Estimate and Closing Disclosure forms.
While the loan interest rate is important, it’s wise to also consider the APR, which is the total cost of owing money on that loan every year.
APRs can significantly differ when you are comparing loan rates. It’s important to look at the nominal interest rate and the APR to get an accurate picture of what the loan may cost you. When you borrow money for a used vehicle, the APR will typically be higher than that for a new vehicle purchase. Having a good credit score can help you qualify for lower APRs than someone who has a lower credit score.
What fees are included in APR?
The annual percentage rate you’ll pay typically consists of the interest rate you’ll pay to finance a loan each year, plus any other fees that may apply to your specific loan. Depending on the loan type, additional fees in the APR may include:
- Points
- Third-party or lender fees
- Mortgage insurance
- Discounts
- Closing costs
- Other charges
You can avoid paying annual percentage rates on loans, including credit cards, by paying off the balance you owe each month on or before the scheduled due date. When you leave a balance owed any month, the interest for the loan is added to the remaining balance at the end of each billing cycle.
When you carry your credit card balance over from month to month, even if you’re making payments, you’ll incur what is known as residual interest.
How Is APR Calculated?
Lenders usually base their APR on the current U.S. prime rate as calculated by the Federal Reserve. That agency reports the current rate by using the prime rate figures posted by most of the biggest 25 banks in the U.S., the Federal Reserve notes. Many lenders opt to then set the annual percentage rates partly on the expected rate level for federal funds. Lenders take that rate and usually add a margin or a small fee to that to come up with the APR. Some variables can determine how much APR is associated with your loan, including your credit score and how you plan to use your credit card.
Depending on certain economic factors, the prime rate may shift. That means that annual percentage rates that are based on the prime rate can fluctuate. Check whether your lender offers fixed-rate credit cards and whether you qualify for them.
What’s The Difference Between A Fixed Rate And A Variable Rate?
There are some important differences between fixed-rate and variable-rate loans. A fixed-rate loan offers the advantage of knowing what your payment will be each month. You’ll have a fixed interest rate locked into the loan. This helps you understand how much you’ll pay over the entire loan, which can help add some predictability to your budget.
The interest you pay on a variable rate loan, also called a floating or adjustable-rate loan, fluctuates over the length of the loan according to market conditions. Variable interest rate loans tend to be more appropriate for higher-risk borrowers, partly because the total cost of the loan is unpredictable. They might also benefit those who plan to own their home for a short number of years. A reputable lending professional can help you determine which loan type might be right for you.
What Is Residual Interest?
You may incur residual interest or trailing interest when you don’t pay your credit card balance in full before or on the payment due date each month. It’s automatically calculated on the amount you carry over between statements. You’ll compile compounded, residual interest daily between the issuing of your new statement and the day your payment is posted.
Paying your credit card off in full each month is the only sure way to avoid being charged residual interest.
Learn More About Loans, And Related Finances
Want to learn more about loans, ranging from auto and mortgage loans to credit cards? The more you know, the better you’ll be prepared to make critical financial decisions.
Check out our blog or these articles to learn more about loans, credit, and managing your finances:
- Can Personal Loans Build Credit?: Learn about personal loans and the effects they can have on your credit score.
- What to Look for in a Savings Account: Learn why a savings account is an essential step to achieving your financial goals.
- Why Getting Preapproved Before Buying a Car is Smart: Want to know if a new car purchase is in your budget? Learn how to know if it’s the right time for you to buy.
- How to Build an Emergency Fund: Learn how to build an emergency fund that may help you pay your expenses if you encounter unforeseen circumstances.
- Debt-to-Income Ratio: How to Calculate Your DTI: Learn how lenders use your DTI along with your credit score to assess the overall risk of loaning you money.
- 7 Reasons Your Credit Score Suddenly Dropped: Learn some important factors that can affect your credit score calculation.
- How to Build up Your Credit Score From Scratch: Learn about short-term solutions that can help you build your credit score when you don’t have any or much credit history.
