What Is APR? How Annual Percentage Rates Work

When you take out a loan, you must pay to borrow the money. In addition to the interest that you'll pay to borrow the funds, you might also incur fees and other costs.

To understand the true cost of borrowing, you'll want to look not just at the interest rate but at the annual percentage rate, or APR.

But what is APR, and how does it differ from the interest rate? Read on to find out the key differences, as well as how to get the best APR when borrowing money.

What is APR?

A credit card or loan APR is one of the most important factors to consider when you're borrowing money.

“APR is the total cost of a loan,” explains Domenick D'Andrea, an accredited investment fiduciary (AIF) and co-founder of DanDarah Wealth Management. “This will include the interest rate and any fees incurred in the processing of the loan.”

APR provides a full picture of all the costs you'll be responsible for if you take out a loan or get a credit card. It's not the same as interest alone.

“APR and interest rates are both stated as percentages and relate to borrowing costs, but they differ in scope,” says Doug Roller, a financial adviser and owner of Crossroads Financial Group. “Interest rates represent the basic cost of borrowing the principal loan amount, while APR provides a wider view.”

APR vs. interest rate: What's the difference?

APR and interest rate are sometimes the same, but they're typically not.

“APR can include different fees and expenses associated with the loan,” says Clifford Cornell, certified financial planner (CFP) and associate financial adviser at Bone Fide Wealth, LLC. “Interest rate is a bit more simple in that it does not include those fees. These two can be equal, but more often, the APR is higher than the interest rate.”

If you're shopping for loans, APR is the feature to focus on.

“When comparing loans, you should always compare the APR and the interest rate to decide which loan is a better option for you,” advises D'Andrea. “If you only look at the interest rates, you could end up spending more on the loan with the lower rate because the lender charges higher fees to set up the loan.”

How is APR calculated?

Most lenders have an APR range. When they issue loans or credit cards, the APR falls within that range. However, exactly where you fall within it will depend on your individual financial credentials.

Lenders typically charge a higher APR if you have a lower credit score and are more likely to default. Borrowers with strong credit might qualify for a lower APR, as lenders feel more confident that they will make their payments reliably.

A good APR also depends on the kind of loan that you are using. Personal loans generally have lower APRs than credit cards, while mortgage loans often have lower APRs than personal loans.

Types of APR

There's more than one type of APR. A few different kinds of APRs include:

• Fixed APR: This will not change for the entire life of the loan, so your monthly payments also remain the same. You don't have to worry about rates rising.
• Variable APR: Variable APRs can change over time. They're usually tied to a financial index like the federal prime rate. If the prime rate goes up, the APR also goes up, and borrowing costs more. Monthly payments increase when this happens.
• Standard APR: A standard APR is the basic APR that applies when you get a credit card or loan. It's not a special, promotional APR, but instead is the rate set based on the lender's APR range and your financial details.
• Introductory APR: Some credit cards offer an introductory APR. This is a promotional APR that applies for a limited time, either on transferred balances or new purchases. For example, a card might offer a 0% introductory APR on purchases for the first 12 months.
• Cash advance APR: Many credit cards charge a higher rate if you access cash with your credit card. There may also be up-front fees for cash advances, which add to your APR.
• Penalty APR: Borrowers who violate the terms of their credit card contract may owe a penalty APR. This is a higher-than-normal APR for a set period of time that applies after mistakes such as missed payments.

When you compare loan offers and look at the APR, be sure to understand if it's fixed or variable and whether it's your standard APR or a special promotional rate.

How to get the best APR on a loan or credit card

To get the best APR on a loan or a credit card:

• Improve your financial credentials: The stronger your credit, the lower your APR will generally be. This means you should take steps like making payments on time and paying down debts to improve your credit score and become a less risky borrower in the eyes of lenders.
• Shop around: You should compare rates and terms with multiple lenders to make sure you're being offered the lowest possible APR for your financial situation.