What is APR? Definition, examples, and payment calculator

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If you’ve been shopping for a credit card or a loan, you’ll find that each bank and credit card company advertises a different set of benefits. However, one thing that will always come up is the credit line’s annual percentage rate, or APR. APR refers to the price that you’ll pay when borrowing money – including both interest costs and other fees that might be associated with the loan. These expenses are calculated on an annual basis to give consumers a clearer idea of what the credit will cost over the course of a year.

Even though many people use the terms “APR” and “interest rate” interchangeably, the truth is that there is a distinct difference between these values:

• Interest Rate: The percentage value that you are paying for the loan.
• APR: Includes interest as well as any other associated fees, such as closing costs, origination fees, or service charges.

As you can see, APR is a more complete picture of the amount of money you are going to pay for the credit that you are receiving.

While both interest rates and APR are important, APR is the more important number that you need to pay attention to. APR was developed to give you a more accurate comparison when you are looking at different financial offerings.

Including all fees in the calculations provides more transparency, making it easier to make the best financial decisions for your needs.

Understanding representative vs. personal APR

There are two types of APR that lenders use. Representative APR is often the way lenders advertise the rates. This information includes standard terms that many people can qualify for, but these rates aren’t guaranteed for every application.

Breaking down the numbers: only 51% of applicants qualify to receive the advertised representative APR. Personal APR is calculated based on a borrower’s credit profile, including both their current income and financial history.

So, essentially half of borrowers are offered a higher rate. Understanding this dynamic is essential because it helps borrowers see why personal APR rate is important when they are applying for credit.

Why is my APR so high?

If your APR is higher than the representative APR, there may be several factors contributing to it. Some of the main factors that could impact your real APR are your:

• Credit history: A higher credit score and strong history of on-time bill repayments usually leads to a lower APR.
• Current financial situation: Lenders will likely assess your current regular income, your savings and outstanding debts, and credit utilisation when determining your real APR.
• Past dealings with the lender: Additionally, lenders will take a look to see if you’ve borrowed from them in the past and how it went.

A major reason credit card companies offer high APR is because they don’t have many options when it comes to recovering their money if users fail to make payments. Where a bank may be able to repossess a house or car if you miss repayments, credit card companies have limited options.

Reporting your missed payments to credit reference agencies or issuing a CCJ, credit card companies can penalise you, but they don’t guarantee that they’ll actually see their payment. High APRs allow credit card companies to compensate for the increased risk they take on when extending a line of credit to users with no credit or poor credit.

Related Read: What is the Average Credit Score in the UK?

How APR works with credit cards

Most adults have at least one credit card, and it’s important to understand how APR works on this type of revolving credit. When credit card APR is calculated, it includes multiple rates:

• Purchase APR: This rate is based on the cost of everyday transactions and is usually the lowest APR for the account.
• Cash Advance APR: Cash advance APRs tend to be the highest, and interest will start accruing immediately.
• Balance Transfer APR: Some credit cards offer the option to move debt from another card. Sometimes, promotional rates are offered to encourage people to consolidate their debt on this card.
• Penalty APR: If payments are late or there is a breach of terms, then a penalty APR can kick in, which is usually a much higher rate.

All of these APR rates serve specific purposes based on the way the consumer is receiving the money.

What to know about APR and personal loans

There are a few differences that are important to understand when comparing personal loan APRs with credit card APRs. Loans often have additional fees that are included in the calculations, such as origination costs for the loan.

If you have a shorter-term loan, then it’s likely that the APR will be higher since there is a smaller window of time for the repayment period. So, the additional fees increase the overall percentage.

While APR is important to consider, it’s also essential to look at the total repayment amount when you reach the end of the loan. The terms and payment time will impact the amount of money you pay in the long run.

Hidden aspects of APR

Remember that you need to evaluate all of the details when choosing a credit card or loan for your unique needs. For example, APR doesn’t always include every cost. Ask about other expenses that might be added to your account, such as prepayment penalties, late fees, or optional insurance expenses.

The frequency of your payments will have an undeniable impact on the overall cost that you pay when borrowing money. If you are looking for ways to reduce your effective interest rates, then paying bi-weekly (instead of monthly) is a great strategy to consider.

The most important thing you can do is look at the full borrowing cost. Instead of relying on APR alone, make sure that you understand other details, especially when you have a credit card with fluctuating rates or varying APR types.

Common APR pitfalls to avoid

There are a few things that you should keep in mind to be smart about the way you are utilizing credit. For example, even though a 0% APR offer seems like a great deal, this rate doesn’t last indefinitely. Usually, there is an expiration date for the promotion, then the account will start applying higher interest rates.

Also, other things can increase your APR. One example is if you miss a payment, then penalty APRs can kick in, negating the benefits of the promotional rate you had initially.

For these reasons, it’s essential that you look at all of the details of the loan instead of relying on APR alone. When making a decision, you must also consider other fees, payment terms, and repayment flexibility.

How to make APR work for you

There are several things that you can do to take advantage of better APRs. Start by improving your credit score. If you have a higher credit score, then lenders will view you as a lower risk and will offer more competitive rates. Make sure that you always compare lenders, and don’t hesitate to negotiate the terms whenever possible.

Sometimes, promotional APRs can be leveraged effectively. For example, you might transfer a balance to use a low promotional rate, then pay down the debt quickly. Some borrowers use these promotional rates as a way to make large purchases without incurring extra costs.

In some cases, it might make sense to take a higher APR if the loan terms are better overall. Look at the overall costs and the flexibility in the payment schedule in order to find the financial solution that is an ideal fit for your unique needs.

The bottom line: Understanding APR is essential for your financial health

The better your credit score, the more confident lenders and credit card companies will be when they extend you a new line of credit. If you’re new to building credit or have poor credit, improving your credit score can seem like a daunting task. But fortunately, Pave is here to make it easier.

Through bills monitoring, personalised credit fixes, and active credit building, Pave helps members build their credit score to receive favourable interest rates, better credit cards, and secure the credit lines they need to turn their dreams into reality.

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