You may often hear the term “APR” but not know what it means or how it works. That’s understandable—many people have misconceptions about it. APR, or annual percentage rate, is the total cost of borrowing money. It is expressed as a yearly percentage, which includes the interest rate plus any associated fees and charges, such as lender fees, closing costs, insurance, and payment protection charges.
When borrowing funds, you need to understand all the costs associated with those funds. Remember, if you purchase something using credit, the actual cost is not just the purchase price but also the interest and fees added.
How Does APR Work?
The APR represents the cost of borrowing money and is calculated by determining how much the loan will cost you each year based on its interest rate and finance charges. Ultimately, the lower the APR is, the more affordable borrowing on that account will be. If you are unsure how much you may be paying, contact the lender to ask for the APR they are using and any applicable fees you are paying.
Types of APR: Fixed vs. Variable APR
APRs can be fixed or variable, and they determine whether the interest rate will remain the same throughout the loan’s lifetime or change over time. When obtaining a loan, the lender will provide this information. If you are unsure, ask about it.
- Fixed APR: The interest rate on a loan or credit card purchases remains unchanged throughout the loan’s life.
- Variable APR: The interest rate may change over time, and the terms and conditions often define how often it can change.
The benefit of a fixed-rate APR is that it allows for predictability. You know how much you will pay over time. In some situations, fixed APRs are offered at a lower rate than variable APRs, but that’s determined based on the lender’s objectives.
Variable APRs will change over time, which means they could drop lower to offer more affordability to borrowers. However, they can also increase, and that could be a factor to play for in most situations.
APR vs APY: What’s the Difference?
Another term you may hear is APY, which stands for Annual Percentage Yield. Both of these are interest rates.
- APR applies to loans and borrowing. That is the rate of cost you will pay to use those accounts.
- APY applies to the interest earned on an investment, such as a Share Certificate, money manager account, or savings account.
Also, note that APY is compounding interest, which means the interest rate is applied to the total amount invested and the earnings from one month to the next.
You may also hear the term simple interest APR. This is a straight fee applied to the funds you borrow. It does not include compounding interest, which APY does.
When comparing the two, the APY is likely to have a higher overall cost due to compounding. If you are unsure how it impacts you and the types of accounts you have now, contact our team to learn more about APY and how it applies to your situation.
How Is APR Calculated?
APR can be calculated in numerous steps. Remember, you do not have to do this since the lender will handle everything behind the scenes. However, it helps to understand how the process works so that you can determine what you are paying when borrowing money from lenders or credit card companies.
The APR formula is:
APR=(((Interest charges + Fees & Charges)/ Principal)/Number of days in loan term ×365) ×100
Here’s what those terms mean:
- APR: annual percentage rate
- Principal: This is the loan amount
- Fees and Charges: This includes any fees and charges associated with borrowing
- Interest charges: This represents the cost of borrowing money or the interest rate the lender is charging you
You can also use a free APR calculator found online, and Experian has one that is easy to use.
Factors That Affect APR
The amount you pay in APR will change from one lender and loan to the next. Some of the most common factors that impact the APR the lender charges you include the following:
- Credit score: Interest rates are higher for those with a lower credit score. There is more risk in lending to a borrower based on the borrower’s habits—the higher your credit score, the less risk and, therefore, the lower the fees.
- Loan amount: The loan amount is the amount you are borrowing. The more you borrow, the higher the risk to the lender, which can drive costs up.
- Promotional offers: Some lenders offer promotional offers, such as 0% APR, for a specified period. This means that the APR applies for the specific amount of time provided within the offer. After that, it will revert to the normal amount.
- Loan term: The length of the loan can also impact the APR charged. Longer loans may have a lower APR in some situations.
- Penalty APRs: In some situations, a lender may charge a higher-than-normal APR if you are late with payments or your balance exceeds your credit limit, which can also impact your credit score.
Lenders will disclose all of this information to you when establishing the account. The value will vary widely between lenders, but all should provide you with information upfront and accurately.
Why Is APR Important for Borrowers
APR provides a clear understanding of the total cost of borrowing compared to the interest rate charged. It clarifies what it will cost if you borrow those funds. Lenders must provide this information to their borrowers under the federal Truth in Lending Act.
As you consider where to borrow from or which type of loan to use to meet your financial needs, compare APRs across all lenders. This gives you a better idea of which loan may be more affordable and what costs you can expect to pay overall.
How to Compare Loan and Credit Card APRs
A lower APR is typically the best choice when you borrow the money you need. Lower APRs mean lower borrowing costs. As you obtain loan offers, take the following steps to compare each of the loan APRs and fees associated with the account:
- Look at the disclosed APR.
- Determine if any additional fees are listed or what types are included.
- Read through any penalty APRs or details about when APR rates may change.
Read the fine print in any account you choose. This will help you make the best decision about borrowing the funds.
APR and Credit Scores: How Are They Connected?
Another factor to consider when calculating APR is your credit score. The lower the risk you present to the lender, the lower the cost of borrowing. A good credit score helps improve your qualifications for a lower APR, making borrowing less expensive.
To improve your credit score and qualify for lower APRs, follow these tips:
- Make payments on time all the time.
- Set up automatic payments so there is no risk of missing a payment.
- Keep the amount of money you are borrowing as low as possible.
- Make sure to utilize your credit line to help you build credit.
- Check your credit report for accuracy.
Those with better credit tend to pay less to borrow money over time. It’s worth putting in the work to reduce those costs to you.
How to Lower Your APR
As you work to improve your credit score and gain more experience in building credit, you may reduce your APR. There are various ways to do this:
- Negotiate with your lender. Give them a call and ask for a lower APR. They may offer you a better rate if you’re a good customer.
- Consolidate your debts. If your credit score has improved over time, you can consolidate your debts with higher APRs into one new loan at a lower rate.
- Consider refinancing: Take out a new loan to pay off the existing loans with a higher APR.
- Pay off high-interest rate balances first when making payments each month. Pay these off as quickly as possible.
Understanding APR for Smarter Financial Decisions
Understanding APR and what it means to your financial borrowing is critical. It enables you to make better decisions about which credit cards and loans you should choose. If you’re unsure which options are best, look at HFS FCU’s loan offerings. We offer competitive rates on many of our products.
Get the Best APR with HFS
HFS FCU’s loan products offer the most competitive interest rates and terms to fit our members’ needs. If you can borrow funds to consolidate or save on interest, we encourage you to check out our rates. You can see all of our share rates and loan rates online.
If you are looking for a new loan or need more details, contact HFS FCU online or visit our website for any information on specific loan products.
FAQs
What is a good APR for a personal loan?
The lower the APR, the better. There is no average APR for personal loans since many factors affect what you can expect to pay.
Can APR change over time?
Yes, APRs can change over time if the lender discloses that information within the loan documents provided to you. Read through the fine print to find out if APRs may change.
How does a better credit score affect my APR?
A better credit score shows lenders you are less of a risk of nonpayment. That means they are more likely to offer you a lower interest rate.
Is APR the same as the interest rate?
No, there are differences here. APR includes your interest rate and applicable fees, which gives a more complete picture of the cost of borrowing.
How do I avoid paying APR on my credit card?
You can avoid paying any APR or interest on your credit card by paying off the amount you borrow each month within the grace period.
What’s the average APR on a credit card?
Data from the Consumer Financial Protection Bureau indicates that the average APR on credit cards in 2023 was 22.8%.
