I’m sure you’ve heard this term before – Annual Percentage Rate (APR), if you haven’t then you probably don’t have any bills, credit cards, or have previously purchased a large item. If you have and you’re not sure what the bloody acronym means, join the club of many teenagers who are not entirely sure themselves. Annual Percentage Rate, or APR, is what you’re charged for any amount that is not paid before interest is accrued. Many people confuse APR with a standard interest rate and it’s not the same thing, entirely. An interest rate is part of the APR but it’s not the APR, there are many factors that go into your APR.
So, what is an APR?
Well, as stated above – an APR is the annual percentage rate that is charged to you, the customer, for any balance not paid before the interest on the account is accrued. It is the actual rate of interest as well as any fees that are charged for your purchases. The interest is accrued at the closing of the billing period and is calculated on the total balance held at the time of close. This is the total cost of financing whatever you’ve purchased. The APR will almost always be higher than the advertised rate and it will be in any disclosure of financing documents.
Each creditor will have their own rate structure, penalties, and fees – it can really get confusing trying to stay on top of all of this and knowing exactly what you’re paying for a single item. The APR is a simple way to provide a base number for comparison on what you’re going to pay. How much a person has to pay in interest and fees determines the total cost of purchase. You may, and should, compare APRs from different products to help decide which one is the better deal for you financially.
How does APR work on a Credit Card?
APR works on a credit card similar to how it does when you finance a single item. Here is an example. You have a credit card with an APR of 20%. You’d take that 20% and divide that by 12 to get your monthly interest rate, or 1.67%. The creditors will need to know this number because they add that interest onto your balance either daily or monthly. If they are trying to figure out the daily interest rate you just take the original 20% and divide it by 365 days in the year.
With credit cards, you may notice another term we haven’t covered – the APY or Annual Percentage Yield. This takes into account the interest that is compounded each month where the APR does not. Make sure you pay enough to cover the principle on the credit card and not just the interest. If you’re only paying to cover the interest on your card you need to start making larger payments.
How is APR Calculated?
For APR to be calculated properly it depends on two factors: the U.S. prime rate and the creditor’s margin rate. The U.S. prime rate is the rate you hear all of those financial experts talk about on the news when trying to determine if the base rate will rise or lower. The margin rate is what the creditor adds to the base rate so that they make extra money off of the interest. For example, if the prime rate is 3.5% and the creditor charges a 5% margin rate then your APR will be 8.5%. An APR typically sits on the higher end in terms of interest rate because the creditor wants to make as much back as possible – even people with the best credit scores still get a high APR.
Floating or Fixed APR
Nearly every loan uses a fixed APR which means you interest doesn’t change while the loan is active. You’ll see this on a longer term loan like a house, car, or a personal loan. A floating APR is when the interest rate is adjusted once during the life of the loan and then it’s set to a fixed rate for the rest of the loan life. A credit card typically uses a floating APR until they can figure out your spending habits and how much of a balance you’re going to carry. If you have bad habits they may inflate the APR and make you pay more interest. There are times where a creditor may charge different APRs for different types of purchases and is most often seen on credit cards.
How does your APR get determined?
So, now that you know what an APR is and what to look for, how do YOU determine what you’ll get for an APR? Well, you can’t determine it 100% and here is why. We already told you it’s based on the U.S. prime rate so that’s step one. The rate changes all the time, and so does the creditors margin rate which is step two. They will take these two rates and have a “best case scenario” for every credit type. This is where they run your credit and get all of your financial information. Your credit score has a large impact on which direction the APR swings, if you have a low credit score you can expect to have a higher APR. Many companies have rules and guidelines for their partners only allowing them to adjust the interest rate so much for each credit type to stop abusing the customers.
How to Compare APRs
If you’re on the hunt for financing a new car, house, or just looking for that next laptop, you need to shop around for APRs. A lot of times this value is not thrown around until you’re almost ready to sign the paperwork and take out that line of credit. You’ll want to know this ahead of time and make sure you always check other businesses first. Not every business will offer you the same APR. In some cases, you can negotiate for a lower APR and we suggest you do so if you can. There are ways to improve your APR but they tend to cost money and at the discretion of the company and there is no guarantee that you’ll get it. A good example of this is when you’re buying a house you can put a larger down payment down and it will help lower the APR saving you money in the long run.