If you have recently applied for a credit card or a loan, you might have stopped and wondered “What is APR?”. No, it is not just the usual interest rate! Continue reading to find out what the Annual Percentage Rate is, how to calculate it and why is it so important.
What Is APR? Quick Glance!
In case you always thought interest rates and APR are one and the same thing, you are in for a surprise. Interest is basically a percentage of the principle amount that lender will charge you when you have borrowed money.
How is APR different then?
Besides the interest rates, it also takes in to account other fees you need to pay in order to receive the loan. It gives you a clearer idea of how much the loan will cost you.
In a nutshell:
“annual percentage rate is your interest rate stated as a yearly rate. An APR for a loan can include fees you may be charged, like origination fees. It is important because it can give you a good idea of how much you’ll pay to take out a loan.”
How To Calculate APR
This is going to be much easier than you would imagine! Here’s is a simple formula you can use to calculate APR.
Don’t worry! We are further going to breakdown the formula for you so it makes more sense. Let’s say you have opted for a loan with following details:
Amount of loan: $1000.
Loan term: 180 days.
Interest fee: $75.
Origination fee: $25.
First thing first! As the formula says, add the interest fee ($75) and origination fee ($25). You will get a total of $100.
Now the next step is to divide the sum ($100) with the amount of loan ($1000). Now you will be left with 0.1.
Divide 0.1 with the loan term that is 180 days. (0.1/180=0.00055556).
Now,all that is left to do is multiply the answer with 365 days of the year. After this you again need to multiple the number you obtain with 100. And you are done! In this example, the total answer should 20.28%.
What Are Different Types Of APR?
There is no rocket science here. Mostly you will have to deal with either a fixed or a variable APR.
This APR does not change based on an index when the loan is on-going. They are predictable and will help you set your budget in a more planned manner.
This is tied to an index interest rate and can change when the loan is on-going. For example, if the mentioned prime rate increases, the Variable APR would also increase.
Variable APR can change for good or for bad. It can potentially lower the interest rates or increase the associated index. Your luck!
Note! “Whenever you take out any type of debt, make sure to find out the different types of APRs you could be charged and what triggers each one. Most of the time, it’s pretty straightforward. If you need help ask the lender to explain when each APR applies.”
In case you are applying for a credit card, you will come across several different types of APRs. Here’s what some of them mean:
Let’s assume that you have not paid off your balance on the monthly statement. In this case, the credit card company will charge you a purchase APR every time you make a purchase using the card. This only applies when you are carrying a balance on the card.
This is also known as promotional annual percentage rate. This can mean a lower APR but only for a limited time span. Introductory APR may also be applied to specific transactions only such as cash advances or balance transfers.
Balance Transfer APR
This is the interest you will pay on all the balances you transfer to the card. Once it is over, a regular balance transfer APR will be applied.
This one is pretty straight-forward! This is the rate you will be charged with in you are late on payments. Typically, it is set at 29.99%. However, there are few cards that charge a lower penalty APR.
Is It Important To Know What Is APR?
Technically, it is super important that you know what APR is as it is the price you are paying to borrow the money.
APRs can help you determine which debts to stay away from. Generally, loans with high APR would mean the interest payments can empty your pockets quicker than you think. Red flag! On the other hand, even if you find out a debt with low APR taking out too much might still not be a good idea.
Some other things to keep in mind especially when you are applying for a credit card are:
- Always review the terms and conditions related to annual percentage rate before you apply or start using a card. Also remember that a company must inform you 45 days earlier when making any changes to the previously stated terms.
- Typically, lender don’t charge annual percentage rate in the first year. However, APR can change during this course so it is better if you stay up-to-date with any alteration.
Frequently Asked Questions About APR
1. What kind of fees are usually taken in to account when deciding the annual percentage rate?
Ans. This largely depends on which loan you are applying for. But as a rule of thumb, you can keep some factors in mind. Origination fees and transaction fees are typically included in it whereas others, like that of late payments etc, are normally excluded.
It is also suggested that if you are dealing with a larger transaction, let’s say a mortgage etc, then prefer taking an expert’s say on what will be included in the annual percentage rate calculation.
2. Is it possible to get the lowest APR?
Ans. You can do so by considering a balance transfer. This means you will pay for one credit card using another card. This will let you enjoy a 0% introductory APR by which you can save significant amount of money.
3. Does calculating annual percentage rate have any limitations?
Ans. The calculation is not free of its limitations and difficulties. One such problem is that of the time period. It is not easy to compare APRs for separate loans that have different time duration.
Knowing what APR is can be a great deal of help when you are making huge purchases, applying for a loan or getting a credit card. You can always use this information to make better financial decisions. Especially when think a lower interest rate is what you need to look at when you are getting a loan. But, in fact, it is the Annual Percentage Rate that gives a better idea of what the loan will cost you overall.