An annual percentage rate (APR) is the annual interest rate on a loan, credit card, or other lines of credit. It is expressed as a percentage of the total amount owed.
APR Definition and Examples
A loan's annual percentage rate (APR) is the total amount of interest paid each year. This is calculated before compounding interest is applied. The annual percentage rate (APR) is expressed as a percentage of the loan balance. When you borrow money, any interest you pay raises the price of the items you purchase with that money. Credit cards, like loans and lines of credit, are forms of borrowing. Knowing the APR of a credit card or loan allows you to compare offers. It also displays the true cost of what you are purchasing. For example, a credit card with a 10% APR might pay around $100 per $1,000 borrowed per year. All else being equal, the loan or credit card with the lowest APR is usually the cheapest.How Does APR Function?
When you borrow money via a loan, credit card, or another line of credit, you must pay interest on the amount borrowed. The annual percentage rate (APR) is the total rate you pay for that loan or credit balance each year. The APR and interest rate on credit cards are frequently the same. Other loans, such as mortgages, require you to pay closing costs, which are factored into your APR. However, credit card fees such as annual fees and late payment fees have no effect on your APR. When you carry a balance on your card, your card issuer uses the APR to determine how much interest to charge you. Many credit card companies charge interest based on your daily balance. This is the balance you owe at the end of each day. The credit card company converts your APR to a daily periodic rate by dividing your APR by 360 or 365. Assume your APR is 20%, and you have a $6,000 daily balance on your card for the month. Your credit card company assumes 365 days per year. How much interest must you pay today? Find the daily periodic rate to do this. Then multiply that daily rate by the balance in your account: 20% / 365 = 0.0548 percent x $6,000 = $3.29 You owe $3.29 in interest for that day. Lenders must include your APR (or multiple APRs) on your statement. As a result, you can see how much debt you have at each rate at any time. Contact your credit card company or loan servicer if you have any questions about those rates. Your loan documentation or cardholder agreement explains how lenders can change your interest rate. Credit card companies are required to abide by the terms and conditions of your agreement. You must pay an APR on loan such as a mortgage. This is because you will be paying interest on the loan each month until it is paid off. However, you are not always required to pay interest with a credit card. The majority of credit cards include a grace period. You can borrow money and pay no interest as long as you pay off your entire card balance each month. If you carry a balance on your card, you will be charged interest at the APR.Effective APR vs. Nominal APR
An APR can help you understand how much it will cost you to borrow money or use a credit card. However, it is not without flaws. The figure you see quoted by a credit card company is a nominal APR. But what if you pay fees at an ATM, such as cash advance fees? When you pay additional fees, and effective APR is a more accurate representation of your borrowing costs. This includes fees that increase your card balance.APR (fixed vs. variable)
An APR that is fixed does not change over time. For the duration of the loan, a fixed-rate mortgage would have the same interest rate and APR. Most credit cards, however, have a variable interest rate. (Some store-brand cards have fixed interest rates.) With a variable rate, your interest rate can fluctuate. This is typically in response to an index, such as The Wall Street Journal's prime rate. Even if you have a fixed rate, your card issuer can change it. If this occurs, they must notify you, usually at least 45 days in advance. Borrowing money becomes more expensive as interest rates rise. Compare your current rates to the average credit card rate to see if you're getting a good deal. The Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009 requires lenders to notify you of a rate change at least 45 days in advance if you have a fixed interest rate. This rate is typically only applicable to new purchases. Federal law also governs rate changes used by lenders to penalize you if you pay more than 60 days late (or more).How Is Your APR Determined?
Your APR is frequently affected by interest rates in the broader economy. Your lender may add a sum (referred to as the "margin") to an index such as the prime rate. Add those two figures together to get your rate. Lenders, for example, may state that you pay the prime rate plus 9%. Assume the prime rate is 3.25 percent, and the APR on your credit card is the prime rate plus 9 percent. To get your APR of 12.25 percent, multiply 3.25 percent by 9 percent. If your card issuer bases billing calculations on 365 days per year, your daily periodic rate would be.034 percent, which is 0.1225 divided by 365. Mortgage lenders frequently base your interest rate on your creditworthiness. They may price your card or loan based on current interest rates and the risk of lending you money. You are less of a risk if you have a higher income, less debt, and a good credit score: the lower your APR, the lower your risk.APR Varieties
APRs on credit cards and lines of credit can vary. This means you will pay different interest rates depending on your credit use.Type of Rate
Description
Important Details
Purchase
- The price you pay for the majority of your purchases
- This rate usually applies when you use your card to make purchases online, at merchants, or pay bills.
Introductory
- A possible rate as a new customer
- These rates may be low at first, but they have an expiration date, and your rate will eventually rise.
Balance transfer
- The interest rate you pay on debt is transferred to your credit card
- You may begin with a low promotional rate and later face a rate increase. You may also be charged a balance transfer fee.
Cash advance
- The fee you pay to withdraw cash from an ATM (or other cash-like transactions)
- Rates are typically high, and you may be charged a second cash advance fee.
Penalty
- A rate increase as a result of late payments
- Your interest rate rises, but you may be able to lower it with a series of timely payments.
Important Takeaways
- Borrowing money with a loan, credit card, or line of credit requires you to pay interest.
- The annual percentage rate (APR) is the interest rate charged on your balance over the course of a year, which may differ from the daily or monthly interest rate.
- A variable APR fluctuates as interest rates rise and fall.
- Your credit card may have multiple APRs that apply to various types of debt.
