What is APR and Why You Need to Know How it Works?
What is APR?
An APR (annual percentage rate) tells the recipient of a loan how much they will be charged for borrowing those funds over the course of a year. The APR considers interest rates and extra charges to provide an indication for how much a borrower will pay over a 12-month period.
APR are three letters that get thrown around a lot, but what does APR mean? More importantly, what does APR stand for? APR is short for 'annual percentage rate'.
You can see why banks and lenders would use the acronym rather than the full term in their TV commercials. Using the phrase 'what is APR?' is much more efficient than asking 'what is an annual percentage rate?
How Are APRs Different From Interest Rates?
There is one significant difference between the interest rate definition and the annual percentage rate definition. An interest rate is exactly that: it represents the amount of interest that the borrower will pay on their loans. Interest rates are often displayed for a monthly term, but APR looks at charges on a yearly basis.
Some companies might try and lure you in with a competitively low-interest rate, but make sure you check the APR - this will tell you the true cost of the loan or credit card.
APR takes this to the next level by also including other fees that arise when taking out a loan. Additional charges could include:
- Origination fees
- Closing costs
- Transaction charges
- Mortgage insurance
When wondering what is APR in the past, you might have been unsure why it was much higher than the interest rate. It is because the APR incorporates all of these extra charges.
What is APR in Everyday Life?
APR has a huge impact on everyday life, given that it determines how much you'll pay for borrowing. Before you take on a new personal loan or credit card, make sure you are able to manage the APR. If the APR is too high, then it could lead to penalty charges down the line.
There could be lots of different APRs in the same offer, particularly in the case of credit cards. In addition to the standard purchase APR, there may be APRs specifically for transferring balances or making cash advances.
Take the time to familiarize yourself with every aspect of the APRs, as you don't want to be hit by surprise charges.
What are Different Types of APRs?
While the general APR definition remains the same, there are variations on how an APR works. Here are the two main types of APRs: fixed APRs and variable APRs.
Fixed APR Definition
A fixed APR ensures that the interest rate will not change throughout a pre-determined time period, whether it is the lifespan of a loan or a period of use for a credit card. This means that a borrower knows exactly what costs they will be liable to pay over the course of a loan.
Variable APR Definition
A variable APR loan has an interest rate that can fluctuate throughout the loan period, with changes in the rate often driven by wider financial trends. A variable APR can work in the borrower's favor, as a lower interest rate reduces costs. However, if interest rates increase then a borrower's expenses will also rise.
Hopefully, you are now more confident at answering the question 'what is APR?'. There are a few important things to remember when taking out loans or credit cards:
- Take the time to compare APRs across several lenders, as you may be offered different interest rates.
- Be sure you know your APR obligations before signing any contracts - is it fixed or variable? Is there multiple APRs?
- Don't get drawn in by low-interest rates - compare the APRs for a better indication of your borrowing costs.