What is the APR? How is it different from APY and how to calculate it


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  • An APR is the cost of borrowing money, expressed as an annual rate.
  • You can use the APR to compare loan offers because it shows what you’ll pay back in interest, plus fees.
  • APRs can be fixed or variable and calculated as simple or compound interest.
  • Visit Insider’s Investment Reference Library for more stories.

When you use a credit card or take out a loan, your lender will charge you interest for the privilege of borrowing money. They will usually present this cost as an annual percentage rate, or APR, which shows your total cost of borrowing, plus fees. Because they help you compare deals and find the best deal, it’s important to know how they perform.

What is the APR?

An APR is the cost of borrowing money expressed as an annual rate. While the APR is typically applied to consumer debt, like credit cards and loans, it can also represent the return on your investment.

“In most cases, [it’s] the most important factor to understand when borrowing or saving money, ”says Brian Stivers, investment advisor and founder of Stivers Financial Services in Knoxville, Tennessee. This is because it helps you “understand the real cost of borrowing money and not just the monthly payment.”

For example, you can use APRs to compare the costs of borrowing a mortgage. Let’s say Lender A and Lender B both offer an interest rate of 2.75% and give you a list of the fees you will pay on the loan.

It can be difficult to compare these fees as they can have different names. In addition, you will need to calculate the numbers. But the APR takes those charges, along with the interest rate, and translates the information into a unit that you can quickly measure. In this example, let’s say Lender A charges an APR of 2.90%, while Lender B offers an APR of 3.50%. At a glance, you can see that the loan from lender B has more costs besides what you are borrowing.

That being said, it’s always a good idea to calculate the interest you will pay over the life of a loan when the interest rates are different. You could end up paying less interest on a loan with a higher APR, and you will need to determine if the higher fees are worth it.

How does the APR work?

On a loan, the APR includes the interest rate plus any fees charged by the lender, such as origination, legal, or underwriting fees. APR isn’t that complicated on a credit card – it’s just the interest rate shown as the annual rate.

The APR was designed to give borrowers more information about what they are actually paying to borrow money. Thanks to the Federal Truth in Loans Act (TILA), lenders are required to disclose the APR on every consumer loan agreement before the borrower signs the agreement. The TILA disclosure also includes other important terms, including:

  • Financial charge, or the cost of credit expressed in dollars.
  • Amount financed, which is usually the dollar amount you borrow.
  • Payment information, such as the monthly payment, the total number of payments you will make, and the sum of all your combined payments (which includes principal plus finance charges).
  • Other information, such as late fees and prepayment penalties.

When you apply for a loan and receive the TILA disclosure, it can be written in the loan agreement. It’s a good idea to review the entire contract and make sure you understand the terms before signing on the dotted line.

How is the APR calculated?

The formula for calculating the APR is as follows:

Formula Chart for How to Calculate APR (Annual Percentage Rate)


Alyssa Powell / Insider


Where n = number of days in the loan term.

Check out an example to see how it works. Let’s say you take out a personal loan of $ 5,000 with a loan term of two years and a set-up fee of $ 400. The total interest you pay over the life of the loan is $ 980. Follow these steps to calculate the APR:

  1. Add up fees and interest: $ 400 + $ 980 = $ 1,380
  2. Divide this number by the principal or the amount you borrow: $ 1,380 / $ 5,000 = 0.276
  3. Divide by the number of days in the loan term: 0.276 / 730 = 0.00037808219
  4. Multiply what you have by 365: 0.00037808219 x 365 = 0.138
  5. Now multiply by 100 to find the APR: 0.138 x 100 = 13.8%

What is a good APR?

A good APR is simply affordable for you, but there are a few general rules you can follow when shopping. For example, the National Consumer Law Center says APRs above 36% are unaffordable.

But it also depends on the type of financial product and the duration of the loan. The APR on a car loan can be higher than on a mortgage, but the longer term of a mortgage means you will likely pay more interest over time.

The APR varies depending on the type of financial product you purchase, but it also depends on the lender’s overhead costs. For example, an online lender often has lower expenses than a large bank with physical locations. “With lower expenses, they can generally charge less APRs to reach their profit margin,” says Stivers, “than a larger lending institution with many locations and more employees.”

APR vs APY

Here’s what to know when comparing APR with APY:

APR vs interest rate

Some people think that APR and interest are one, but they have different meanings when it comes to loans. “The interest rates only reflect the percentage of interest charged on the loan,” says Stivers. “The APR includes the additional costs associated with the loan.”

Some of these additional costs include discount points, loan origination fees, and other sales charges.

Here’s a good way to think about it: you’ll use the interest rate to calculate your monthly payment, and use the APR to estimate the total cost of the loan and compare offers.

Types of APR

Many credit products, such as mortgages and auto loans, come with only one APR. The APR can be fixed, which means it never changes, or variable, where it can increase or decrease over time.

Other types of debt, such as credit cards, can charge more than one APR. This is because “lenders, in general, have different APRs for different risks,” says Stivers. “For example, a balance transfer from one credit card to another usually presents a lower risk because the consumer has already paid the payment to the company that issued the original credit card. credit may reduce its APR because of the perceived less risk than a brand new purchase with no payment history. “

A credit card may charge a different APR depending on the type of transaction you are doing:

  • Purchase APR: applies to purchases you make with your credit card. “Credit card companies will often use a lower APR, sometimes 0%, for a short period – anywhere from six months to a year – to entice a consumer to use their credit,” says Stivers.
  • APR balance transfer: applies to debts that you transfer to your credit card. Some credit cards offer a promotional low APR on balance transfers.
  • APR cash advance: applies when you borrow money from the line of credit. This APR is generally higher than the purchase APR.
  • APR penalty: applies when you make a late payment or miss a payment completely. The credit card issuer must follow certain rules before applying an APR penalty to your account.
  • Launch / promotional APR: a low APR that applies to certain transactions – such as purchases or balance transfers – for a limited time. The timeframe varies depending on each card, but is generally between 12 and 18 months.

However, keep an eye on your credit card balance when it comes to a promotional APR. “Credit card companies are realizing that few consumers will pay off debt in the allotted time,” Stivers says, “and then raise the APR to much higher rates at the end of the promotional period.”

The financial report

The annual percentage rate is a useful way to measure the total cost of borrowing. On a loan, it’s based on the lender’s interest rate plus any fees they charge, while on a credit card it’s just the rate expressed as an annual rate. Knowing the APR before taking out a credit card or loan is important because you can use this number to compare deals and finding the best deal can help you save money.

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