If you’ve ever taken out a credit card or a loan — or even if you’ve just seen advertising for them — there’s a good chance you’ve seen the term annual percentage rate (or APR, for short). APR is the total annual cost of borrowing money.
You’re likely to run into APR when you’re borrowing money. It’s important to understand what it means and how it’s calculated since it represents the additional amount your borrowed money will cost you each year. The higher your APR, the more expensive your debt.
How APR Works
Annual percentage yield (APR) is the annual cost of borrowing money. It’s paid by the borrower to the lender, usually on a monthly basis. APR is expressed as a percentage rate. For example, you might have a credit card with an APR of 20%, which means you’ll pay 20% of your balance each year on top of your balance.
Just about every loan or revolving credit you borrow will have APR associated with it, including your credit card, mortgage, student loan, auto loan, and more.
APR is calculated by multiplying your periodic interest rate by the number of periods in the year. For example, for interest that accrues daily, you would multiply the periodic interest rate by 365. You would then multiply it by 100 to see the number represented as a percentage.
Note: Your periodic interest rate is the interest rate and fees divided by the loan amount and then divided by the loan term.
Here’s what the formula for APR looks like:
APR = [(((Fees + Interest) / Principal) / Days in Loan Term) x 365] x 100
No matter how you’ve borrowed money, whether in the form of a credit card or loan, you should be able to easily find out your APR. The Truth in Lending Act (TILA) of 1968 requires that lenders disclose APRs to borrowers. Your APR should always be disclosed before you actually borrow the money.
APR vs. Interest Rate
The terms APR and interest rate (also known as the nominal interest rate) are often used interchangeably, but the two aren’t always the same thing. The interest rate on a loan is a percentage that a lender applies to your principal balance as the cost of borrowing money. The APR, on the other hand, is your interest rate, along with any loan fees. The combination of the two is the total annual cost of the loan.
That being said, your interest rate and APR are only different for loans. On credit cards, your interest rate and APR are the same things since there are no fees added to it on top of the interest rate. So if your credit card APR is 18%, your interest rate is also 18%.
Types of APRs
There are several different types of APRs. It’s important to understand which you might be subject to for your credit cards and loans. Below are some of the most common types:
A fixed APR remains the same for the entirety of the loan. Fixed APRs are common on installment loans such as student loans, auto loans, and mortgages.
A variable APR can change throughout the life of the loan. Variable APRs are common with credit cards, but there are also variable-rate loans.
A purchase APR applies to new purchases on your credit card.
A balance transfer APR is one that applies when you transfer your balance from one credit card to another. It may be the same as the purchase APR or have a promotional APR.
A promotional or introductory APR applies for a set period of time (often one year) after you sign up for the card. Introductory APRs are often 0% and are a way to entice people to sign up for the card.
A cash advance APR applies to cash advances on your credit card. This APR is usually higher than your purchase APR.
A penalty APR may be added to your credit card if you have a late or missed payment on your credit card or have a payment returned.
APR vs. APY
Similar to APR is an annual percentage yield (APY). These terms essentially mean the same thing, but in the case of an APY, you’re the one receiving the money. APY is usually applied to savings accounts and other deposit accounts that pay interest on the money in your account. Think of it like an APR where you’re the lender, and your financial institution is the borrower.
APR vs. Daily Rate
The APR of a credit card or loan shows the cost of borrowing money over an entire year. A daily rate, also known as the daily periodic rate, is the amount it costs each day. The daily periodic rate is used because some accounts, especially credit cards, accrue interest on a daily basis.
Your daily periodic rate is important because it helps determine the amount you’ll actually pay in interest. Chances are that your credit card balance fluctuates throughout the year. Some days you might accrue interest at your daily rate. But some days, you might have a $0 balance on your credit card, meaning no interest would accrue.
Another important note about your daily rate is that it compounds. In other words, the daily interest you accrue each day is added to your credit card balance, meaning it also accrues interest moving forward. If you’ve ever struggled to pay off credit card debt and feel like your balance just won’t shrink, compounding interest is probably one of the reasons.
Frequently Asked Questions
What is a good APR on a credit card?
According to CreditCards.com, the average credit card interest rate in mid-August 2022 was 17.99%. However, the rate you’re eligible for will depend on your personal finances.
What is a good APR for a car?
According to Experian’s State of the Auto Finance Market report in the first quarter of 2022, the average APR on a new car was 4.07%, while the average APR on a used car was 8.62%.
Why is my APR so high?
If you have a high APR on your credit card or loan, it may be a result of your credit history. Generally speaking, a lower credit score will result in a higher APR. However, certain types of debt — especially unsecured debt — tends to have higher rates.
Is APR charged monthly?
How often APR is charged depends on the type of debt. In the case of credit cards, APR is charged daily. However, for certain loans, APR only accrues monthly.
Does 0% APR mean no interest?
0% APR means there’s no interest on the debt, but usually only for a short time. Credit card companies often offer 0% introductory rates as a way to entice borrowers to sign up for their cards.
Next Steps for You
Understanding the APR on your credit cards and loans is critical, since it determines the amount you’ll actually pay for your debt. While the average APR may vary depending on the type of debt you have, your personal finances also play an important role. The better your credit score, the lower the APRs you’ll be eligible for, and the cheaper you’ll be able to borrow money.
If you’re working to pay off debt, the Personal Capital Financial Dashboard can help. The budgeting tool can help you find money in your budget to put toward debt, while our net worth planner can help you track your progress while you pay down your debt.
Author is not a client of Personal Capital Advisors Corporation and is compensated as a freelance writer.