What is APR? You may find yourself asking this question for a variety of reasons, for example, when applying for a credit card or comparing business loan offers. You must have probably seen the term APR when financing a purchase. Whether it is a significant item such as mortgage or auto loan or something small like groceries or clothing. It is also a very important term when comparing credit cards. Many people assume that APR is the same thing as the interest rate. Let’s get understand in more explicit ways what is the annual percentage rate (APR)? Here Is Everything That You Need To Know.

This is a major component of the APR, other factors go into determining what it is as well. It is critical to understand the full meaning of APR before you commit to a credit card or loan, otherwise, you could end up paying more than you initially planned. When you get a card with a 0% rate and your goal is to pay the balance in full before interest is charged, you need to know how much interest and other fees you will have to pay just in case.

As it is too easy to learn, finances do not always go as planned. So, prepare yourself to make fully informed decisions by being able to compare the APRs of multiple credit offers. In this article, we are going to share with you information about what an annual percentage rate (APR) is, how to calculate it.

Annual Percentage Rate (APR) Defined

The annual percentage rate (APR) is defined as the cost per year of borrowing. APR is not as exactly as the interest rate on a loan. Loans charge you an interest rate and also charge other fees, such as closing costs, origination fees or insurance costs, which are typically wrapped into the loan.

When the two loans have the same interest rate, but one has much higher fees than the other, simply shopping by interest rates will not give an accurate comparison of the loans’ true costs. That is why there is the APR. By factoring in other fees, APR offers a more accurate estimate of the cost per year of a loan. As a result, the APR is generally higher than the interest rate.

The annual percentage rate is charged to a customer for any amount not paid before interest is accrued. It has the actual interest rate as well as fees that are charged for the purchase. In essence, it is the total cost of borrowing whatever you are buying. The APR will be higher than the advertised interest rate if there are other charges and it must be included in any disclosures regarding financing.

Because each creditor has its own rate structure, penalties and transaction fees, it can get confusing to understand exactly how much you are paying for an item. The APR seems quite the easiest way to offer a base number for comparison.

How much a person pays in interest and fees determines the total cost of the purchase. You may compare APRs from different products to decide which one is a better deal. Before deciding on a product, it is important to understand what an APR includes,

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How it works and how it impacts your finances?

APR impacts your finances in many ways. It does not matter if you are trying to understand your credit card statement better or seeking a loan for your small business, once you understand the answer to the question as to what is APR, including the finer details of APR, you will have an easier time managing your finances and knowing when your APR is too expensive.

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There are different types of APRs

(a) Promotional APR

(b) Variable and non-variable APRs

Thus, the lower the APR, the lower is the cost of borrowing. Having a high business credit score can assist you achieve a low APR.

Types of APR Explained

There are many reasons for being puzzled surrounding APR, including the fact that a credit card account can have multiple APRs. Many people draw close attention to the APR for purchases. They are aware of one thing that if they carry a balance from one month to the next, this is the rate that will use to calculate how their balance is impacted.

However, there may be other types of APR, such as those connected with balance transfers.

What Are Promotional APRs?

Some lenders take interest to offer a promotional APR.  And also offers you a lower rate on certain transactions for a predetermined period of time. Consider, you may find a credit card offer with zero percent APR for six months. When the promotional period concludes, the APR will adjust to a higher amount, thus increasing the cost of carrying a balance.

What Are Variable and Non-Variable APRs?

Variable and Non-Variable APRs

The name pretty much says it all, but let us take a closer look at the differences between variable and non-variable APR.

A variable APR is exactly what it sounds like – with this, your annual percentage rate (APR) can vary over time. This is evaluated by adding the margin, managed by the credit card company, to the index (or reference rate), such as the Prime Rate. When Prime Rate goes up, so will your APR. Ultimately, if the Prime Rate decreases, your APR will follow, thus making it cheaper for you to borrow money.

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The Board of Governors of the Federal Reserve System defines the Prime Rate as

“The prime rate is an interest rate set by individual banks. It is also known as the base rate for many types of  commercial loans, including loans to small businesses and credit card loans.”

On the other hand, a non-variable APR is often preferred, as this means the rate stays the same indefinitely. You know what you are getting, which lessens the chance of a surprise down the road.

Note: Read the fine print, as many credit card offers with a non-variable rate are not guaranteed. The issuing company is entitled to change the APR based on a variety of factors, such as market conditions and how often you use your credit card. They are required to notify you of any change.

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How to Calculate APR?

How to calculate API - annual percentage rate

In order to calculate the annual percentage rate (APR), first, you need to know the interest, the total loan amount, the terms and the fees.

Let us assume that you are borrowing $10,000 and have been quoted an interest rate of 12%. Also, you have to pay a $500 closing fee. So, the APR on your two-year loan would be roughly 16.92%. How did we get this number?

The easiest way to evaluate APR is to use an APR calculator or a spreadsheet. For instance, you can calculate the monthly payment and closing costs for the scenario described above with built-in formulas.

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Consider the following steps

1. Type the following formula into any cell to calculate the monthly payment for your loan:

=PMT (interest rate/months, the total number of months you pay on the loan, loan value plus fees)

=PMT (.12/12, 24, 10500)

Your monthly payment would be $494.27.

2. When you determined the monthly payment, you can use a second formula to determine your APR:

=RATE (total number of months you pay on the loan, your monthly payment expressed as a negative, the current value of your loan)

=RATE (24, -494.27, 10000)

3. Your monthly rate should be .0141. Multiply by 12 to get an annual rate:

.0141 * 12 = .1692

4. Ultimately, multiply by 100 to convert from a decimal back to a percentage:

.1692 * 100 = 16.92%

What Fees Does APR Include?

The fees included in APR can and will vary from one lender to the other. Following are the fees:

  • Underwriting fee
  • Loan processing fee
  • Private mortgage insurance fee (if applicable)
  • Document preparation fee
  • Loan application fee

Though not always true, these are the fees that are not typically add

  • Attorney fee
  • Abstract fee
  • Title fee
  • Credit report
  • Transfer taxes
  • Appraisal fee
  • Home inspection fee

Note: Consult each lender for more information on what in the APR. This makes sure that you are comparing apples to apples, allowing you to make an informed and confident decision as to which loan is cheapest.

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How Does APR Work On Credit Cards?

The APR is only one number you will see on transactions. All of these terms can get confusing if you don’t know what they mean and understand the differences.

Another term you will hear about is the daily periodic rate, which calculates interest rates. It refers to the interest that is charged on a regular basis on your purchase or loan. It is the APR divided by the number of days in one year — 65. The monthly periodic rate is the same, except the APR is divided by 12.

Here is an example in practical terms.

A credit card (or loan) holds an APR of 15%. The daily periodic interest rate is around 0.041% while the monthly periodic interest rate will be 1.25%. Creditors must know these numbers because they add interest to your balance on either a daily or monthly basis rather than annually.

The second term is the annual percentage yield or APY. It takes into account the interest that is compounded each month, while the APR does not. Say you borrowed $1,000 with an APR of 12%. The monthly periodic rate is 1%, which creates the interest for that period of $10.

When if nothing is paid on the principal, then the balance goes up to $1,010. The next month, the interest charged will be a little bit higher because it is compounded on the $1,010 rather than the original $1,000.

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How Do APR and Interest Rate Differ?

Although we touched on this above, it is important to reiterate – it is a common myth that APR and interest rates are one and the same. While these numbers could be close, do not expect them to be exactly the same. Often, an APR can be higher than an interest rate.

Here is an example

You are a business owner interested in buying an office building and have been offered a $200,000 loan at an interest rate of six percent.

As focused as you may be on the 6%, however, do not overlook the fact that this is not the APR. The reason is simple — the APR includes the interest expense, as well as other costs and fees associated with the loan. These costs and fees are not the same from lender to lender. The APR is almost always higher than the interest rate.

When you compare multiple lenders and loan products, do not forget to focus on both numbers. You may find a situation in which two lenders are offering the same interest rate, but a different APR. The lender offering the lower APR is charging fewer fees and is offering a better deal.

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APR and the Truth in Lending Act (TILA)

In the United States, the disclosure and calculation of APR has been governed by the Truth in Lending Act since its original effective date of May 29, 1968.

The U.S. Department of Treasury provides the following in regards to how the act protects consumers:

“The Truth in Lending Act (TILA) guards you against inaccurate and unfair credit billing and credit card practices. It requires lenders to offer you loan cost information so that you can comparison shop for certain types of loans.”

For many years, the Truth in Lending Act was effective in creating an environment of honest reporting and clarity amongst borrowers and lenders.

In the 1980s, this all changed when auto-makers, among other companies, began to exploit a loophole in which they could reduce finance charges, but make up for it by increasing the price of the car.

Many changes have been made over the years to fight against deceptive practices. For example, provisions were added to the Mortgage Disclosure Improvement Act of 2008 (MDIA) to provide homebuyers with more concise information.

This clause determines that if the final APR is off by 0.125 percent or more on the GFE disclosure, the lender must issue another disclosure and wait for a period of three additional business days before finishing the transaction.

The Federal Deposit Insurance Corporation (FDIC) is responsible for enforcing laws and regulations associated with consumer protection as it relates to APR.

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There are rules that govern the following

  • Tolerance
  • Rounding
  • Periodic rates
  • Finance charges
  • Good faith reliance on faulty calculation tools

Fortunately, as a consumer, you do not have to concern yourself with the many rules and regulations that govern lenders. As long as you can answer the question, “what is APR?” you can rest easy knowing that there are many governing bodies with a close eye on lenders and lending practices.

3 APR Facts You Need to Know

Any misconception in regards to the question, “what is APR?” such as how to calculate it, could lead to a situation in which you are surprised at what you are being charged.

These three facts will assist you better understand your situation.

(a) A higher credit score will qualify you for a lower APR. It does not matter if you are applying for a business credit card, seeking a home mortgage, or in need of a business loan, a high credit score will work in your favor. There are many benefits of a high business credit score, with this being at the top of the list.

(b) There are ways to get a lower APR but do not count on this happening. If you want to secure a lower rate, there are things you can do.

Contact the lender and request a lower APR. Make sure you have a leg to stand on, such as details of a better offer from another lender.

  • Enroll in a debt management program. This is not for most people. Instead, it is only for those who are having a difficult time meeting their monthly obligation. In this case, the lender can lower the APR on a temporary basis to help the person or business get back on track.
  • Apply for a hardship plan. This is similar to a debt management program. The primary difference is that this type keeps the lower APR in place until the balance is paid off.
  • A lower APR is always better, but you should not expect to be in a position to negotiate this on a regular basis (if at all). This is why it is so important to seek the best offer upfront. It may not sound like a big deal when applying for a loan or credit card offer, but one APR point can make a huge difference. Over the course of more than 10 years, a reduction of one percentage point will save you thousands of dollars.

(c) Paying the balance in full is the best way to go. This definitely holds true with a credit card. If you never carry a balance from one month to the next, you will not have to concern yourself with paying interest.

This may be an option with a credit card, but not with others, such as a business loan.

What Is APR? Here are the FAQs

Finally, you completely understood how to answer the question, “what is APR?” including its basic definition and how to calculate it, it is time to go for some of the more detailed questions.

What is the purpose of APR?

From a borrower’s perspective, APR helps them understand how much they will pay to take on a loan.  it allows them to measure the cost of credit, making it easier to compare loans.

Is APR the same as AER and EAR?

All three are the same, but this is not the case. AER, also known as Annual Equivalent Rate, is a calculation for interest rates that make the association with bank savings accounts. EAR stands for Effective Annual Rate.

Way to avoid a high APR

There is no way to avoid a high APR, however, there are some things you can do to improve your position. Most importantly, maintain a good credit score. Higher scores come with lower APRs. Additionally, shop around. For example, if you are in the market for a business loan, rely on a service that helps you find the best deal. Lender is likely to have a lower APR and better overall terms, than the rest of the field.

Is it the best idea to use an APR calculator?

While the lender can offer you with all the calculations you require, it is never a bad idea to use an APR or business loan calculator as a way of running different borrowing scenarios. This is often the best way to fully get details of the loan, including how the APR impacts your overall monthly, weekly or daily payment.

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Is APR the Only Thing That Matters?

It is very easy to have a one-track mind when it comes to applying for a credit card or loan. With a loan, your goal is simple: secure the funding you need to make a purchase, without paying too much to do so. There is no disagreement that the benefits of comparing the APR associated with multiple loans. If all else is the same, the APR could be the determining factor. The lower the number the less you will pay in interest and fees.

Despite the importance, this is not the only thing that matters.

There are other details to consider, such as

  • The reputation of the lender
  • The lender’s customer service
  • Collateral
  • Term
  • Payment options
  • Penalties (such as those for prepayment)

Note: Your way of comparing APR numbers for a loan will not be the same as a credit card. With a loan, you will absolutely be paying fees to receive the capital. This means the APR will definitely come into play. With a credit card, this is not always true, since you have the option of paying your balance in full every month.

Bottom Line

If you are still wondering, “What is APR?” do not hesitate to consult with the credit card company or financing company you are willing to do business with. As you continue to grow your small business or improve your personal finances, you may find yourself interested in some type of loan (business loan, mortgage, etc.) or in business credit cards. With each step that you take, make sure these three letters are in the back of your mind: APR.

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