What is APR and why is it important?

Written by: Lance Cothern, CPA
• Updated •5 min read • Leer en español

In a Nutshell

APR, or 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. APR is important because it can give you a good idea of how much you’ll pay to take out a loan.
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APR is how much it costs to borrow money.

Let’s take a look below at why APR is important, how it’s calculated and when you might encounter it.

Why is APR important?

It’s super important that you’re aware of the APR you’re paying on any debt you take on because it’s the price you pay to borrow the money.

Generally, you’ll want to stay away from debt with high APRs because the cost could end up overwhelming your budget.

When could you encounter APR?

You’ll likely come across APRs mainly when dealing with credit. Many types of credit products, such as car loans and mortgages, might only have one APR you have to pay attention to, but other types of debt may have multiple APRs.

For example, when you receive credit card offers in the mail, you may see several different APRs listed. There may be a purchase APR listed in the card’s terms and conditions, but you may also see a balance transfer APR, penalty APR or cash advance APR, too.

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. That said, if you need help, ask the lender to explain when each APR applies.

Types of APR

It’s also important to know the type of APR on your loan. In most cases, you’ll either have a fixed APR or a variable APR.

Fixed APR

A fixed APR means the APR doesn’t change based on an index during the life of the loan. Because of this, fixed APRs can be more predictable when it comes to budgeting. Common examples of loans with fixed APRs include most mortgages and personal loans.

Variable APR

Variable APRs can change and are tied to an index interest rate, such as the prime rate published in the Wall Street Journal. So if the prime rate increases, so would a variable APR.

Variable APRs can fluctuate either in your favor or against it. So while a variable APR could potentially provide lower interest rates upfront, it can also increase as the associated index increases, which is a downside of variable APRs. You’ll often see this type of APR on credit cards.

What is the formula for calculating APR?

Calculating APR isn’t as difficult as you might think. Here’s the formula you would use to calculate the APR of a loan with fees. Note: If a loan doesn’t have fees (and this is rare), you can simply replace the fees placeholder in the formula with a zero.

what-is-APR-formulaImage: what-is-APR-formula

If that sounds confusing, take a look at how we break it down in the following example.

Let’s say you take out a $1,000 loan. And over a 180-day loan term, you’ll end up paying $75 in interest and a $25 origination fee to take out the loan.

Let’s do the math to calculate your APR.

  1. First, add the origination fee and total interest paid.

$75 + $25 = $100

  1. Then, take that number and divide it by the loan amount.

$100 / $1,000 = 0.1

  1. Next, divide the result by the term of the loan.

0.1 / 180 = 0.00055556

  1. Then, multiply that result by 365.

0.00055556 x 365 = 0.20277778

  1. Finally, multiply that by 100 to get the APR.

0.20277778 x 100 = 20.28%

FAST FACTS

What fees are usually included in APR?

Depending on the type of loan you take out, there could be many fees included in the APR, or no fees at all. So how do you tell which fees are included? There are a number of factors that feed into each APR, but there are some general rules of thumb you can follow to get a better idea.

Fees connected to a specific loan are typically included in the APR calculation. These fees can include things like loan origination fees and transactions fees. But some fees are excluded, like fees for unanticipated late payments.

If you’re dealing with a large transaction, like a mortgage, it’s helpful to talk to an expert about what is and isn’t included in your APR so that you understand the APR you’re being quoted.

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What affects your APR?

Technically, the lender determines what interest rate to offer you when you apply for a loan, which will affect your APR. But there are a number of factors that can play a big part in determining your interest rate, too.

Lenders are likely to consider your credit scores, along with other factors, when offering you an interest rate. Someone with excellent credit scores is likely to get a lower interest rate than someone with lower credit scores for the same loan, assuming all other conditions are the same.

By shopping around for the best loan deal, you may be able to find a lender who can offer you a lower APR.

For example, while one lender may offer you a variable 15% APR loan, another lender might offer you a variable 12% APR loan, even if you apply on the same day with the same exact information. That’s why it can pay to shop around.

It’s important to note that a good APR may be different depending on the type of credit you’re applying for. For instance, the average APR offered on credit cards is generally higher than the average APR offered on mortgages. So while it doesn’t make sense to compare credit card APRs to mortgage APRs, you should compare APRs within the same loan type.

APR vs. interest rate

Some people think interest rates and annual percentage rates are the same thing. While that’s typically true for credit cards, the terms have different meanings when it comes to loans. So when you’re considering taking out a loan, recognizing the differences between the interest rate and the APR will help you understand the cost.

An interest rate is a percentage of the loan principal that a lender charges you to borrow the money. So what is APR? Instead of just including the interest rate, APR can also include fees you may be required to pay to take out the loan. So APR gives you a better idea of the entire cost of the loan as a percentage.

APR vs. APY

Though APY sounds similar to APR, it stands for annual percentage yield and refers to the interest you earn on money — like in a savings account, for example. They might sound alike, but APR and APY are different ways of discussing interest — whether it’s interest you owe (APR) or interest you’ve earned (APY).

Bottom line

Having a better idea of what APR is can be especially helpful when you’re making a big purchase or getting a credit card.

You can use this information to make more-informed decisions, especially when comparing multiple loan options. It’s important to remember that while a lower interest rate may be appealing, the APR on the loan can give you a better idea of what you’ll pay for the loan overall.

About the author: Lance Cothern is a freelance writer specializing in personal finance. His work has appeared on Business Insider, USA Today.com and his website, MoneyManifesto.com. Lance holds a Bachelor of Business Administration in … Read more.