Understanding APR: Essential Information You Should Have
The annual percentage rate (APR) is a crucial concept for anyone borrowing money. It represents the total interest rate paid annually over the life of a loan. APR is significant in various financial products like credit cards, auto loans, and mortgages. Credit card APRs are usually higher than those for other loans, making it essential to understand your credit card’s APR.
**What Is APR?**
APR determines the interest charged on borrowed money beyond the interest-free grace period, typically one payment cycle. For instance, most credit cards don’t charge interest on purchases if the balance is paid in full by the next due date. However, loans accrue interest over a longer period. APRs are influenced by factors such as the borrower’s credit score and the issuing bank’s policies. You can find your credit card APR on your statements and account disclosures, while loan APRs are listed in the truth-in-lending statement provided before accepting a loan.
**How Does APR Work?**
APR reflects the cost of borrowing money, including the interest rate and all lender fees, expressed as a percentage. Banks set APRs based on the U.S. prime rate, adding a profit margin. Generally, a higher credit score results in a lower APR. Credit card APRs can range from 15% for excellent credit scores to 30% for poor credit scores.
**Difference Between APR and Interest Rate**
While related, APR and interest rates have different calculations. The interest rate is the cost of borrowing money, while APR includes the total loan cost. For example, a $1,000 cash advance on a credit card with a 20% interest rate and a 2% cash advance fee results in a 22% APR. If there are no additional fees, the interest rate and APR are the same. Typically, APR is higher than the stated interest rate.
**Difference Between APR and Effective Annual Interest Rate**
Credit card APRs use either a daily or monthly periodic rate. Dividing the APR by 365 gives the daily rate, and by 12 gives the monthly rate. The lender adds this periodic accrual to the credit card balance, known as the effective annual interest rate, which is the actual interest rate charged due to compounding over time.
**Difference Between APR and APY**
APY, or annual percentage yield, is the opposite of APR. While APR is the interest paid on debt, APY is the interest earned on deposits or investments. When choosing a credit card or loan, you look for the lowest APR to minimize debt costs. Conversely, for bank accounts, a high APY is desirable to maximize earnings on your balance.
**Good To Know**
Interest compounded daily costs more than monthly compounding. This is important for cardholders who don’t pay off their balance each month. Making a partial payment at the beginning of the billing cycle can save on interest if compounding is daily.
**Types of Credit Card APRs**
There are various APR types associated with credit cards that cardholders should be aware of.