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What is APR? How Does it Affect Loans and Interest Rates?

    

Annual Percentage Rate (APR) isn’t a technical finance term. Still, there are aspects that might confuse you if you're not a personal finance expert. In this post, we’ll go through some of the important basics of the cost of borrowing money to help you better understand the true costs associated with using credit cards or taking out student loans, a mortgage, or other loans.

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APR Definition 

APR stands for "Annual Percentage Rate," which is the amount of interest that will apply on top of the amount you owe on a year-to-year basis.

So, if you have an APR of 30 percent, that means you will have to pay a total of $30 in interest on a loan of $100, if you leave the debt running for 12 months.

As another reference: If it were $10 in interest, that would mean the APR is 10 percent. If you had a 10% APR then you would owe $10 in interest on a loan of $100 if you leave the debt running for 12 months.

See How Your APR Is Calculated 

Your APR rate depends on your creditworthiness, the type of credit you're applying for, and the current borrowing rates.

It's a proprietary calculation made by your credit card issuer or lender. If you are card shopping, you also should look at the purchase APR and balance transfer APR.

Once you apply, you might qualify for the card at a fixed interest rate. There could even be a no-interest period. However, some cards include a range of rates (usually three) and your creditworthiness determines which one applies to you.

Credit Card APR Rates

Remember, there are many types of APR that apply for credit cards, such as: 

  • Cash advance APR
  • Purchase APR
  • Balance transfer APR
  • Introductory offer APR
  • Penalty APR
  • Fixed vs Variable APR

Calculating Your Credit Card APR 

Your credit card's monthly interest cost is determined by dividing your annual APR by 12. If you pay in different installment periods, just use the number of payments divided by 12 to determine your APR.

If your APR is 27.99 percent, then 2.3 percent is applied each month. So, a $1,000 loan would have a charge of $23 monthly, equating to $276 a year in interest.

Because the annual (nominal) APR isn't effective for calculating your realized interest costs, many people find APR confusing.

Now it gets even more confusing when you factor in the effective APR calculations. Your effective APR rate is the figure determined by your compound interest. This rolls in the interest that was applied to your card in previous months.

As a result, a high APR rate can make the amount you owe in interest inflate very fast.

The Difference Between APR and APY

APR is your Annual Percentage Rate, while APY is your Annual Percentage Yield. The latter is more effective when looking at a certificate of deposit. It shows the person that's saving their money what they can expect to yield in a year's time.

The more often you get paid in a year, the more you stand to receive. A monthly disbursement would equate to an APY of 5.12 percent instead of the 5 percent you might have expected.

The APY figure is required by law, as per the FDICIA Act of 1991. Banks must disclose what your APY will be before you sign up for a savings account.

What is a High APR?

Your credit score can impact the APR given to you by lenders. Those with excellent credit typically receive low interest rates on loan credit cards. If you have a lower credit score, it can cause you to have higher APRs. According to the Federal Reserve, the average APR for a credit card was 14.65%. APRs over 20% are considered high but they may be the only APR available to you depending on your credit score.

How Do I Find the Right Credit Card

Different credit cards and companies will offer you different APRs so it's best to shop around even if you have a lower credit score. Some credit card offers include introductory APRs or no interest at all for new cardholders even if they do not have good credit. It's important to also consider other perks when choosing a new credit card like cash rewards, cashback, and no annual fees.

How to Avoid High-Interest Charges

If you already have a loan or credit card with a higher interest rate, you can contact the credit card company or lender to try to get a lower APR or rate if you have paid your bills on time and improved your credit. If you are having financial difficulties and are not able to meet the payments, ask them to waive penalties or additional fees they charge for late or missed payments. If this does not work, borrowers should pay down their credit card debt quickly to avoid high-interest fees on top of the money already owed.

Understanding an APR in Your Mortgage

This is the easiest use of APR for most people to grasp. If you look at a home mortgage loan, the monthly payments, established by the mortgage lenders and set in the loan agreement, are the same each month. Unlike a credit card where you have purchase APR as well, you can predetermine how much you will spend in interest over the life of the loan. This way, any set APR will be easy to understand in terms of total costs for the consumer. When you apply for a mortgage for a new home, get a loan estimate including closing costs and any other lender fees that may be added. They will all help you find the best mortgage. In need of mortgage or refinancing services? TDECU can help. Find out more about how you can refinance your home, get a mortgage, or tap into a home equity loan.

Credit APR Laws

There are some situations where a company cannot exceed a certain APR amount. For example, the FTC determined that some payday loan companies are charging their customers way too much.

When you're getting a credit card or a loan, the APR rate must be discussed with you upfront. This law is a part of the Truth in Lending Act and protects consumers, or homebuyers, by ensuring the loan terms, loan origination fees, and any lender charges are disclosed.

Ready to apply for a loan or credit card? Get started.

 

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