The APR, or annual percentage rate, is a percentage that shows the combined interest rate and additional costs and fees applied to a loan or credit card balance. Understanding APR can be challenging, but we’ll answer common questions about it in this article, including what it includes and how it works.
APR Meaning and Function
APR stands for the annual percentage rate, which is the yearly interest rate you pay on a loan such as a credit card or auto loan. This rate includes the cost of borrowing the money. Generally, a lower APR is better.
APR Calculation
APR is a percentage that shows the fees and costs associated with a loan. The prices and costs will differ depending on the type of loan, such as a home or auto loan. The following are examples of fees usually included in the APR:
- Processing Fees. These are fees banks charge for processing. For a mortgage, this may be an “origination fee.”
- Underwriting Fees. These fees are for reviewing a loan application and making a decision.
- Document Fees. These fees are for drawing up documents for the loan.
- Appraisal Fees. This fee is for valuing a home.
APR helps compare loan rates.
APR vs. Interest Rate
APR includes costs and fees, but the interest rate does not. The interest rate only shows the rate paid for the loan, excluding other expenses. When considering a loan, APR is a better way to compare loans as it provides a more holistic view.
When applying for a loan, you should see both the interest rate and the APR. If you don’t, ask your lender.
Variable APR vs. Fixed APR
Variable APR
A variable APR is determined by adding a margin to a base rate, such as the Prime Rate. The rate is unstable because it can change depending on what the Prime Rate does.
Fixed APR
A fixed APR is a rate determined by your lender. Your credit score usually determines this rate. Some loans and credit cards will go as high as the bank’s minimum rate for that product. A fixed rate can change if certain things happen, such as being late or stopping paying altogether. Read the terms and conditions of your loan to know if and when a fixed rate can change.
Is a lower APR always better?
While a lower APR is generally better, it may only sometimes be true, particularly with mortgage loans. Although a lower APR can be attractive, you may have to pay higher points, closing costs, or other fees associated with closing your home loan, making it more expensive in the long run. Therefore, reading all the fine print and asking for as many details as possible before applying for a mortgage or any other loan is essential.
What is a good APR?
The best APR you can get depends on several factors, including the type of credit you’re using, your credit score, and the prime rate.
What is a good APR for a credit card?
According to the Federal Reserve, the average APR for all credit cards as of August 2022 was 16.27%. Generally, an APR in the low teens, such as 15% or below, is pretty good, although some cards may offer APRs in the 10% range, those are rare.
What is a good APR for a car?
Car loan APRs also vary depending on credit. A good APR for a car loan, for good-credit and fair-credit borrowers, is anything below 5%. The average 60-month APR for August 2022 was 5.50% per the Federal Reserve. Borrowers with excellent credit can get APRs as low as 2.47% for new vehicle loans and 3.61% for used vehicle loans. For more middling but suitable credit ranges, the average is 3.51% for new vehicles and 5.38% for used cars.
What is a reasonable APR for a loan?
The range for typical APRs for personal loans is wide. In August 2022, the average APR for a 24-month personal loan was 10.16%. Borrowers with excellent credit may receive APRs under 8%. However, any APR in the 10% range is generally considered reasonable. Conversely, subprime borrowers may encounter personal loan APRs as high as 36%.
Understanding Credit Card APR: The Three Different Rates Explained
Credit cards are unique loans that categorize your purchases into three groups, each with a corresponding Annual Percentage Rate (APR) often different from the others. These categories are purchases, balance transfers, and cash advances, each with its own APR.
Your credit card statement will show all three rates for each purchase category.
Purchase APR
When you carry a balance on your credit card, you are charged a purchase APR, the interest rate on your credit card purchases. This is the most commonly assigned type of APR for credit cards.
Balance transfer APR
A balance transfer APR refers to any debt transferred from one credit card account to another. It may be higher or lower than the purchase APR.
Many credit cards offer balance transfer promotions for new customers when they open credit cards. These introductory offers give you a 0% or low APR on balance transfers for a limited time (usually anywhere from six to 18 months). The regular balance transfer rate will be applied if you don’t pay off the entire transferred balance within that time frame.
What is Cash Advance APR?
If you withdraw cash from your credit card account, you will be charged a cash advance APR. This means that you will be charged an interest rate, usually between 25% and 30%, much higher than the typical interest rate for purchases or balance transfers. The interest on cash advances starts accruing immediately instead of purchasing APRs, where interest only starts building at the end of the billing cycle.
How Credit Card APRs Work
Suppose you open a credit card and immediately transfer $5,000 at a 0% interest rate (remember that you still pay a transaction fee). After that, you make $1,000 monthly purchases at a 16.99% interest rate. Finally, let’s say that you need $500 in cash from an ATM (which is strongly discouraged), and the cash advance APR is 25.99%.
When you receive your first credit card bill, your new balance will be $6,500 (not including fees), but it will be broken down into three different APRs:
- $5,000 for balance transfers at 0%
- $1,000 for purchases at 16.99%
- $500 for cash advances at 25.99%
If you pay on your credit card, which APR will the payment be applied to first?
Before 2009, when you paid on your credit card, it would be applied to the lowest APR first, which made no sense. This allowed banks to trap their customers into paying higher rates, and consumers could only pay off a higher APR once they paid off all other balances first.
Using our example above, $500 at 25.99% would accumulate interest while you made aggressive payments toward the 0% balance, then the 16.99% balance (after the 0% balance was paid off in total).
Thankfully, the Credit CARD Act of 2009 stopped this nonsense. When you pay your credit card, it gets allocated to the highest APR first so that you can immediately pay off the 22.99% cash advance.
How to Calculate APR
APR helps you compare different loan products, but there should be other factors you consider. Here’s how to calculate your daily APR on a credit card.
Find the Daily Rate
Divide the APR you’re getting on your card by 365, the number of days in the year. This will give you your daily rate, also known as the daily periodic rate. For example, if you have a 17% APR, divide 0.17 by 365 to get about 0.00046.
Factor in Your Balance
Multiply the daily rate by your current balance to determine your average daily APR charge. If you have a balance of $500 on a 17% APR card, your daily rate is 0.00046, and your average daily APR charge is $0.23.
Look at APR for the Whole Month
Multiply the average daily APR charge by the average number of monthly days (30.44). In our example, if your average daily APR charge is $0.23, you’re paying about $7 monthly interest.
Summary
Knowing the APR is the first step in making an intelligent decision as a borrower. It would help if you considered several factors before taking out any credit product, including the monthly payment, the credibility of the institution loaning you the funds, and whether they offer online banking or an app to use on the go. Use the APR as a point of reference and do as much research as possible to make an informed decision.