Explaining APR or Annual Percentage Rate in 3 Minutes
What Does APR Stand For?
When you hear the term “annual percentage rate” or “APR”, typically what someone is referring to is related to a wide range of financial products such as personal loans, mortgages, and other financial products like credit cards.
In function the Annual Percentage Rate (APR) is the total cost of borrowing money from a financial institution. The APR calculates the interest and/or fees assessed in conjunction with your loan balance and serves as a basis for comparing the total costs of similar loans or financial products.
Simply put, the APR is an accurate representation of how much it costs to borrow money. An interest rate is a rate based on the percentage of the principal or balance that a lender charges you to borrow money.
What is APR?
So, what is APR? An APR is the sum of the interest rate plus any extra fees or finance charges you may be required to pay to originate the loan. The APR will give you a clear understanding of the actual cost of the loan product calculated on an annual basis and expressed as a percentage. If there are no additional fees, then the APR will be the same as the interest rate.
Many different types of financial lending products have APRs, including credit cards, mortgages, auto loans, and personal loans. Many people think interest rates and annual percentage rates are the same things, and while that is typically true for credit cards, the terms have very different meanings when it comes to other forms of loans. It’s important to realize that these rates are different, and you should check both the interest rate and the APR when you are comparing loan products.
Whatever type of financial product you have, your APR should be listed on your original loan agreement as well as the statements that you receive. Understanding what your APR is and how it functions is extremely important to managing your debt and structuring your repayment options strategically. This guide will help you understand the APR basics.
What Does An APR Tell Me?
All financial companies in the United States are required by federal lending laws to provide consumers the APR of a loan product as part of their loan agreement or a credit card account agreement to provide a clear and transparent understanding of the actual rates applicable to their products and services. Credit card companies can advertise interest rates they charge monthly, but they are also required to clearly state the actual APR to customers before any legally binding agreement is signed. For example, a credit card may charge 1% interest a month, and its APR is 1% x 12 months, or 12% per year.
APRs for Credit Cards and Mortgages.
APR calculations follow a standard mathematical formula that depends on the type of financial product being offered. Mortgage APRs typically include closing costs and other fees associated with taking out a mortgage. Credit cards typically don’t have upfront fees, so the interest rate and APR are the same percentages.
Why Are APR’s Important for Personal Loans?
When you are considering a personal loan, the APR is one of the most important things to consider because it provides apples-to-apples cost comparison for similar lending offerings. Personal loans and credit agreements can vary in terms of interest-rate structure, transaction fees, late penalties, and other fees. By using a standardized computation of the APR provides borrowers with a simplistic bottom-line number, they can easily compare to rates charged by different lenders for similar products. The interest rate or monthly payment alone does not reflect the actual cost of the lending product.
What Factors Impact My Interest Rate?
Lenders are likely to consider your current credit scores and debt to income ratio along with other factors when offering you a loan with an interest rate offer. Typically, someone with excellent credit scores is likely to get a lower interest rate than someone with lower credit scores for the same type of loan product.
The federal Truth in Lending Act requires that every consumer loan agreement list the APR along with the nominal interest rate. The scenario most confusing to borrowers is when two lenders are offering the same nominal rate and monthly payments but different APRs. In a case like this, the lender with the lower APR is requiring fewer upfront fees and offering a better deal.
Understanding APR is especially helpful when you’re making a financial decision when comparing multiple loan options. It’s important to remember that while a lower interest rate may seem more appealing, the APR of a loan can give you a better idea of what you will end up paying for the loan overall. Hopefully, you can use this information to make more informed decisions about your financial future.
If you have more questions or want to learn more, contact our team at RoundBank today!