What is an APR?

Written by , January 17, 2013

what is an aprAny time you go shopping for a new home loan, car loan or credit card, you’re likely to encounter a lot of “fine print” on the loan or credit agreement. While it’s a good idea to understand all of the terms you’re agreeing to, some terms deserve more of your focus.

One of the most important terms of any credit arrangement, and the one that will impact your cost of borrowing most directly, is the annual percentage rate (or “APR”) of the loan.

What is APR? Annual Percentage Rate is a numerical description of the interest rate that you effectively pay for an entire year for any credit that you receive. The reason the APR is so important is that it allows you to make an “apples to apples” comparison between different loan and credit options, each of which might otherwise state their loan terms and fees in slightly different ways.

  • APRs Do Not Include All Fees. Depending on how a lender charges you for a loan or other extension of credit, an APR may not reflect your true cost of borrowing. For example, any penalties or late fees that you may incur will not be reflected in the APR you pay on the underlying loan or credit balance. In the context of a home mortgage, there are a number of required borrowing costs (such as the appraisal and home inspection fees, as well as the title insurance) which are not incorporated into the stated APR because they are not paid directly to the mortgage lender.
  • Credit Card APR is Activity Specific. With respect to the APR you’re quoted for your credit card, make sure you understand what type of activity that particular rate applies to. For example, if you take advantage of a balance transfer or other promotion that your credit card company may be running, then that balance will likely be at an APR that’s much lower than the APR that applies to other charges. Furthermore, the APR that applies to any cash advances you take on your card is probably going to be higher to standard purchasing activity.
  • Watch for APR Changes. In addition to the different APRs that apply to different types of activity, you should also note that each of these APRs can change over time. If you pay you’re your minimum balance every month, then your credit card company must provide you with at least 45 days notice prior to raising your rate, but if you fall behind on a single payment by more than 60 days then they can raise your rate without any advance notice.
  • What You Should Know About Your APRs. Make sure you understand exactly what annual percentage rate you’re paying on each and every one of your loans and credit card accounts. Be sure to include back in any additional fees in order to come up with a true cost of borrowing; knowing the true cost will help you decide how to prioritize your various loans when coming up with a repayment strategy.

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