Making sense of APRs

When you apply for a loan or a credit card, you’ll see two different numbers on how much it will cost you; the interest rate and the APR (or Annual Percentage Rate). They’re similar concepts with subtle differences in how they’re calculated.

How is your interest rate calculated?

Your interest rate is the amount charged by your lender for the money you’ve borrowed. This is the cost of the debt for you - and the rate of return for your lender. 

How is your APR calculated?

“APR” is an acronym for “annual percentage rate.” It’s your annual cost for borrowing money from a financial institution. This includes your interest rate plus certain fees, such as:

  • Processing fees: These are fees your bank charges for completing your request for a loan or credit card.
  • Underwriting fees: The underwriter reviews your loan or credit card application and decides whether to approve it or not. This fee is for them. 
  • Document fees: These fees are charged for drawing up contracts and agreements that you’ll sign when accepting a loan or credit card.
  • Appraisal fees: For a home loan, this is a fee for a professional to review and place a value on the home you’d like to purchase.
  • Origination fees: This is an upfront fee designed to compensate your lender for putting a loan together.
  • Dealer prep: Auto dealers often include this fee in their APR, as compensation for preparing a vehicle for sale.

Your APR can vary, depending on the loan type or the credit card issuer. But it’s always important. It’s the all-inclusive cost of a loan or a credit card - and a more accurate indicator than the interest rate.

5 steps to calculating your APR

Step 1: Add total interest paid throughout the loan to any additional fees

Step 2: Divide by the amount of the loan

Step 3: Divide by the total number of days in the loan term

Step 4: Multiply by 365 to find the annual rate

Step 5: Multiply by 100 to convert the annual rate into a percentage

How does your credit score impact your APR

Your credit score will determine the APR lenders and card issuers can offer you. A healthy credit score will get you a low Annual Percentage Rate. A bad credit score will give you a high APR. 

In ads and promotions for credit cards, you might see offers of 13.99% to 22.99% APR. But the final number depends on your credit worthiness, calculated based on your credit score and other risk factors. The average APR for U.S. credit cards has ranged between 14% and 15% since early 2018.

APRs for credit cards

There are a bunch of different APRs that can be applied to your credit card account. Some are featured in promotions, others are hidden in fine print. Here are some of the important ones to note:

  • Introductory APR: This is given to new customers for a set number of months when they initially open their credit card. To broaden its appeal, this rate is lower than the regular APR, often as low as 0%.
  • Purchase APR: Whenever you use your card to buy anything, whether it's online or in person, this interest rate will be applied if you don’t pay your balance in full and on time.
  • Balance Transfer APR: This is the interest rate you'll pay on balances you transfer to a credit card or debit card from an existing credit card. It’s often lower than your Purchase APR, to encourage more transfers.
  • Cash Advance APR: This is the interest rate applied when you borrow cash on your credit card. This is usually always higher than your Purchase APR and typically does not come with a grace period.
  • Penalty APR: This is usually the highest APR that can be applied to your account and is applied when a payment is more than 60 days delayed.

The TILA or Truth in Lending ACT passed in 1968 mandates that your lender must disclose the APR they charge you before you sign an agreement.

Loans can provide more financial flexibility. Credit cards deliver purchasing convenience. The more you’re aware of the charges attached to them, the more sensibly you can use all that they offer.

Bright is brilliant at managing credit card debt, finding the fastest, smartest way to lower your interest charges and pay off your cards.