APR: Why knowing the Annual Percentage Rate can help you make a smarter choice

Shopping for loans and credit cards can feel overly complicated, especially when you're bombarded with phrases like “APR” that you’re expected to know. Not everyone knows what APR means or how to use that information. 

You do know how to spot a deal. Here’s the thing. You can shop for a loan the same way you shop for your favorite food items. Once you know what you’re looking at, you can make informed financial decisions that leave more money in your pocket. 

It’s our job to explain how. Let’s demystify.

What is the Annual Percentage Rate?

The annual percentage rate, or APR, of a loan represents the total cost of borrowing money for a year. 

For example, the true cost of a mortgage is more than just the interest you pay. It’s also lender fees and other charges. If you take all the fees and charges and spread them equally over the loan’s repayment term, that’s the additional annual cost that you’ll pay along with the interest. APR is the annual cost of the fees and interest, expressed as a percentage of the amount borrowed. 

For mortgages, home equity loans, and personal loans, APR includes interest and fees. For credit cards, APR is the interest rate you’re charged if you don’t pay off the balance in full each month, not including any fees.

What are interest rates?

Interest is the price for borrowing money with a loan or credit card. Interest rates are expressed as annual amounts. If you borrow $100 at 8% interest and pay it back in a single payment after one year, you’ll pay $108. (In real life, it’s more complex. If you pay off a little bit of the debt each month, you’d end up paying less than $108.)

What are lender fees?

Lender fees are the various charges that you pay for your loan.

Lender fees affect the total cost of a loan and are included in an APR. When there are lender fees, it’s normal for the APR on a loan to be higher than the interest rate. 

Credit cards can also come with fees, but they’re not included in the APR. Most credit card fees are charged for specific uses, such as a cash advance or balance transfer. 

What’s the difference between interest rates and APR?

Interest rates can be lower than APRs because they don’t include lender fees. 

Also, interest rates can be advertised on a monthly basis, which can make them look much cheaper than they really are. APR is an annual, not a monthly, cost.

APR is a more complete measure of a loan’s cost than just the interest rate by itself.

What loans have an APR?

Here are some types of loans that have an APR.

Credit cards

For credit cards, the APR is the same as the interest rate and doesn't include any fees. Most credit card fees kick in only for a specific action (such as a cash advance or late payment). The APR on a credit card doesn’t include those fees because not everyone pays them. Annual fees are also not included in APR. The annual fee is the price you pay for having the card, whether you use it or not, so it doesn't count as a cost of borrowing.

With most credit cards, you can avoid paying any interest at all by paying off your charges each month. 

Mortgages

Fees are common in home loans, so the APR is typically higher than the interest rate. Here are some common mortgage fees:

• Underwriting fees - for evaluating your application

• Mortgage broker fees - for finding you a loan

• Loan application fee - for applying

• Origination fee - for making the loan

• Other closing costs - such as for a property appraisal, credit report, title search, and so on 

Mortgages can have fixed or variable interest rates. For a variable-rate mortgage, the APR represents the cost for the first year only.

Personal loans

Personal loans usually have an origination fee. The APR reflects this fee when the loan requires it. If a personal loan has no lender fees, the interest rate will usually be higher compared to a comparable loan with fees.

You’ll often find the APR for personal loans and other kinds of loans on the lender’s website. The APR should always be disclosed in a loan offer and in the loan documents you sign.

Why the APR on a loan matters

By understanding APR, you can get past advertising language and sales pitches, down to the nuts and bolts of the loan you’re considering. For instance, you might find that the loan with the lowest interest rate comes with additional fees that other lenders don’t charge, increasing the APR. Knowing the APR, or the total borrowing cost, helps you make an informed decision about which loan to choose.

Here are some examples.

Personal loan APR 

Here’s what a personal loan APR might look like with a 10% rate and 4% in fees.

Mortgage APR

Here are two different versions of a 30-year mortgage, showing that a lower interest rate doesn’t always mean you’ll save money.

Other important factors to compare when choosing a loan

The APR is one way to compare offers. But you'll also want to look at other factors, such as the lender’s reputation, whether the lender has the right loan for your situation, and whether you can lock your rate.

Besides the interest rate and fees, other factors can affect your borrowing costs. For example:

• Adjustable-rate loans when the interest rate changes

• Introductory rates that expire

• One-time fees that aren't included in the APR, such as late fees or a prepayment penalty

• Your credit score 

• The amount you borrow 

• The loan term 

• The type of transaction, such as cash advances, balance transfers, and regular purchases

Tips for lowering your APR

You can proactively take steps to lower your borrowing costs. 

The first step is to check your credit score. Lenders usually offer lower rates to applicants with higher credit scores, and there may be three or four different rate categories that you could fall into. Ask what credit score is needed for a lower rate. If you’re only a few points away, maybe you can act to raise your score before you apply. It’s not always easy to do so, but one of the quickest ways to raise your score is to pay down your revolving debt.

Other ways you might be able to lower your APR:

• Add a qualified co-borrower

• If you are using a loan to consolidate debt, allow your lender to pay your loan funds directly to your creditors 

• Show proof of sufficient retirement funds

• Ask the lender if they offer a relationship discount to current customers

• Get prequalified to compare costs

• Opt for a shorter term

• Opt for a smaller loan