What APR Tells You About a Loan

Image shows a home with a car in front of it, a credit card bill, and a notice of debt payment. Text reads:

Image by Jie En Lee © The Balance 2019

When you borrow money, you’ll see the term APR, and you might not be sure what it means. APR helps you understand the cost of a loan, but it can be misleading. Sometimes fees are included, and sometimes the loan with the lowest APR isn’t your best choice.

To use APR, you don’t need to understand the math behind it, but you can always dig deeper and learn how to calculate APR if you want more information.

What Does APR Mean?

APR stands for annual percentage rate. It's different from the interest rate in that it not only includes interest costs, but also fees related to a loan. It tells you how much a loan will cost in one year.

Once you know how much it costs to borrow, you can compare loans and credit cards by comparing the APR.

Example: You borrow $100 at 10% APR. Over the course of one year, you will pay $10 in interest because $10 is 10% of $100. To calculate, multiply $100 by 0.10 to arrive at $10 ($100 x .10 = $10). Note that the percentage is converted into decimal format to do the calculation.

In reality, you’ll probably pay more than $10. The example above assumes interest is calculated and charged only once per year and you don’t pay any fees — which might not be accurate. Credit cards generally charge small amounts of interest daily or monthly (and add those charges to your loan balance), which means you’ll actually pay more due to compounding. With home loans, you typically pay closing costs, which add to the total cost of your loan.

APR is an annualized rate. In other words, it describes how much interest you’ll pay if you borrow for one full year. However, you might not borrow for an entire year, or the amount that you borrow might change throughout the year (as you make purchases and payments on your credit card, for example). To get precise figures, you might need to do a little bit of math.

Nevertheless, you can usually assume that a lower APR is better than a higher APR (with mortgages being an important exception).

With credit cards, you typically break your APR down to a daily rate, because interest is charged on your balance every day, and those interest charges are added to your balance so you can pay more interest the next day.

To figure out your daily rate, take the APR and divide it by 365. If the APR is 10%, the daily rate would be 0.0274% (0.10 divided by 365 = .000274). Note that some credit cards divide by 360 days instead of 365 days.

What Is 0% APR?

If you’ve seen advertisements offering “teaser” deals, you may wonder what 0% APR means. Zero percent APR suggests that no interest will be charged on money you borrow. The lack of interest charges makes it (sort of) like you’re paying slowly, with your own cash, and sometimes deals are advertised as “same as cash.” But you’re still borrowing money, and things can always take a bad turn. Borrowing for free might sound great, but it rarely lasts long; 0% APR offers are designed to get you in the door so that lenders can eventually charge you interest.

Keep in mind that 0%t APR offers can help you save money on interest, but you still might pay other fees to borrow. For example, your credit card might charge a “balance transfer” fee for you to pay off balances on other credit cards. The fee might be less than you’d pay in interest with the old card, but you’re still paying something. Likewise, you might pay an annual fee to the credit card issuer, and that fee is not included in the APR.

It is possible to pay absolutely nothing and take full advantage of a 0% APR offer, but you have to be diligent to pull this off. It’s essential to pay off 100% of your loan balance before the promotional period ends and to make all of your payments on time—if you don’t, you might pay high interest charges on any remaining balance.

Deferred interest is not the same as 0% interest. These programs are often advertised as “no interest” loans, and they are especially popular around winter holidays. However, you will pay interest if you fail to pay off the entire balance before the promotional period ends. With a true 0% offer, you’ll just start paying interest on any remaining balance after your promotional period ends. With deferred interest, you’ll pay interest retroactively on the original loan amount as if you weren’t making any payments. Deferred interest offers are not allowed to be advertised as “0% interest.”

What Does Variable APR Mean?

If an APR is variable, then it can vary (or change) over time. With some loans, you know exactly how much you’ll pay in interest: you know how much you’ll borrow, how long you’ll take to pay it back, and what interest rate is used for interest charges. Loans with a variable APR are different. The interest rate might be higher or lower in the future than it is today (lower would be nice, but higher is more likely).

Variable-rate loans are risky because you might think you can afford to borrow given today’s rate, but you may end up paying a lot more than you expected. On the other hand, you’ll typically get a lower initial interest rate if you’re willing to assume the risks of using a variable APR. In some cases, variable APRs are the only option available—take it or leave it.

What might make your interest rate increase? Variable APRs typically rise when interest rates in general rise. In other words, they rise in sympathy with interest rates on savings accounts and other types of loans. But your interest rate can also increase as part of a “penalty” (whether you have a variable APR or not). If you fail to make payments or hit a universal default trigger, your rates can jump dramatically. You might not have to pay higher rates on your existing loan balance, but you’ll lose the ability to borrow at the lower rate in the future.

Multiple APRs

Speaking of higher rates and lower rates, you might pay a different APR depending on how you borrow. What are these various APRs?

Think about opening a new credit card: you might transfer a balance to that card, make some purchases, and get cash advances from an ATM. Since those are different types of transactions, that most likely means different APRs. Typically you’ll get a low (promotional) APR for balance transfers, a regular APR for purchases, and a higher APR for cash advances. Moreover, as you make payments, your credit card issuer might apply payments to the lowest APR category first—so they can charge interest at the higher rates for as long as possible.

Don’t just assume you know what your APR is. Find out what happens if you do anything besides swipe your card at the store.

APR for Mortgage Comparisons

When it comes to home loans, APR is complicated. It is supposed to be an apples-to-apples way to compare all of the costs of your loan: interest costs, closing costs, mortgage insurance, and all of the other fees you might pay to get a home loan. Since different lenders charge different fees, APR would ideally give you one number to look at when comparing loans. However, the reality is that different lenders include (or exclude) different fees from the APR calculation, so you can’t just rely on APR to tell you which mortgage is the best deal.

What Affects APR?

Whether you pay a high APR or a low APR depends on several factors:

Type of loan: Some loans are more expensive than others. Home loans and auto loans generally come with lower rates because the home is available as collateral and people tend to prioritize those loans. Credit cards, on the other hand, are unsecured loans so you have to pay more as a result of the increased risk.

Credit: Your borrowing history is an important part of any lending decision. If you can show a solid history of repaying loans on time (and therefore you have great credit scores), you’ll get lower APRs on almost every type of loan.

Ratios: Again, it’s all about the risk. If lenders think they can avoid losing money, they’ll offer lower APRs. For home and auto loans, it’s important to have a low loan to value ratio (LTV) and good debt-to-income ratios. Good ratios show that you’re not biting off more than you can chew and that the lender can sell collateral and walk away in decent shape if necessary.

Article Sources

  1. Consumer Financial Protection Bureau. “What Is the Difference Between a Mortgage Interest Rate and an APR?” Accessed Jan. 16, 2020.

  2. Bank of America. “APR vs. Interest Rate.” Accessed Jan. 16, 2020.

  3. Consumer Financial Protection Bureau. “What Is a ‘Daily Periodic Rate’ on a Credit Card?” Accessed Jan. 16, 2020.

  4. Consumer Financial Protection Bureau. “What Is a Balance Transfer Fee? Can a Balance Transfer Fee Be Charged on a Zero Percent Interest Rate Offer?” Accessed Jan. 16, 2020.

  5. Consumer Financial Protection Bureau. “You Could Still End Up Paying Interest on a Zero Percent Interest Credit Card Offer.” Accessed Jan. 16, 2020.

  6. Consumer Financial Protection Bureau. “How to Understand Special Promotional Financing Offers on Credit Cards.” Accessed Jan. 16, 2020.

  7. Experian. “What You Need to Know About 0% APR Credit Card Offers.” Accessed Jan. 16, 2020.

  8. Code of Federal Regulations. “Comment for 1026.60 - Credit and Charge Card Applications and Solicitations.” Accessed Jan. 16, 2020.

  9. Consumer Financial Protection Bureau. “What Is the Difference Between a Fixed APR and a Variable APR?” Accessed Jan. 16, 2020.

  10. Citizens Bank. “What Is APR?” Accessed Jan. 16, 2020.

  11. Experian. “What Is APR and How Does It Affect Me?” Accessed Jan. 16, 2020.

  12. Capital One. “What Is APR (Annual Percentage Rate)?” Accessed Jan. 16, 2020.