Annual Percentage Rate (APR): What It Is And How To Calculate It

Your annual percentage rate (APR) is extremely important to know when applying for credit cards or comparing terms on auto, home, or personal loans. That’s because it’s a financial metric that tells you how much you’ll pay yearly in total for the privilege of borrowing money, including any associated fees or interest charges. Let’s take a closer look at everything that you need to know about how APR works, and how it may impact your financial plans.

What Is APR?

Your annual percentage rate describes the amount that you can expect to pay yearly when borrowing money, including both lenders’ fees and the interest rate charges on the loan amount. Knowing how it works gives you the information that you need to effectively compare loan offers as a borrower, as a higher APR is indicative of a higher overall total cost for the loan. The lower your APR, the less you’ll come out of pocket to borrow money.

Note that when calculating APR, the formula takes into account both loan origination fees applied by lenders and compound interest on any sums borrowed. That means that it offers a more comprehensive look at the total amount that you’ll be spending to secure a new loan of varying types.

In general, the APR formula is: APR = ((Interest charges + fees) / Principal / n x 365) x 100

Types Of APR

APR comes in different forms. Common sorts of annual percentage rates that you can expect to encounter include:

• Purchase APR: The amount of interest that you can expect to pay on everyday purchases and credit/loan balances. You can anticipate encountering (and to be paying it off) on a frequent basis.
• Introductory APR: Sometimes referred to as a promotional APR, an introductory APR is frequently offered at a lowered rate (sometimes as low as 0%) as a way to entice you into signing up for a new credit or loan account. Your promotional rate may be set for a few months up to a year in time and applies to new purchases made during this period.
• Balance transfer APR: Borrowers often have the option of transferring balances from one loan or credit card to another as needed. Should you elect to do so, you’ll typically pay a new, different APR on the amount transferred. Some loan and credit card products seek to entice new customers by offering lower APRs on balance transfers as a way to convince you to sign up.
• Cash advance APR: Should you use a credit card to take out cash, a higher APR (charged separately) is typically applied to these balances.
• Penalty APR: As a rule of thumb, a higher penalty APR – charged if you pay late or tend to miss two or more payments – may be charged by your credit card or loan provider. To avoid getting hit with penalty APR charges above and beyond your lower, everyday purchase APR, you may wish to set up payment reminders or regular recurring payments.

APR Vs. APY

APR and APY are used for different purposes. APR describes the total cost of borrowing money over the course of a year, factoring in interest and associated fees – and it applies to personal loans and credit cards. APY, which applies to investment and savings accounts such as CDs, tells you how much that interest you’ll earn on these investment vehicles per year and gives you a sense of annual rate of return.

APR Vs. Interest Rate

Think of it as follows: The interest rate that you’ll pay on the loan is just how much it will cost you to borrow money from your preferred lender. By way of comparison, your annual percentage rate expresses how much you can expect to pay in total annually, taking into account your interest rate and any additional service fees charged along with the loan.

Understanding simple interest and compound interest can help here. Simple interest describes a fixed interest rate based on your loan principal amount. Compound interest applies new, rising amounts of interest to the total you owe as it compounds monthly, quarterly, semi-annually, or annually each period.

Fixed Vs. Variable APR

Certain types of credit cards and loans may come with either fixed or variable APRs. If you’re assigned a fixed APR, your loan or credit facility is assigned an interest rate that is guaranteed not to change for the entire lifetime of the product. When you sign up for a financial product with a variable APR, it means that the interest rate can change at various intervals typically outlined in your terms, based on market conditions or other variables.

APR Vs. Nominal Vs. Daily Date

A nominal interest rate is one that doesn’t account for inflation, like the federal funds rate. APRs generally tend to exceed the nominal interest rate on your loan, because the nominal interest rate does not take borrowers’ additional expenses into account. Your daily periodic rate describes interest amounts that are charged daily on your loan balance (calculated by taking your APR and dividing it by 365 days). Most commonly though, you’ll find your APR expressed by lenders on a 12-month basis. Keep in mind that the 1991 Truth in Savings Act requires lenders to disclose APR and other rates.

How To Calculate Monthly APR

There are several formulas that you can use to calculate your monthly APR. However, the simplest is as follows:

1. Find your APR and account balance: You can find this information listed on your credit card agreement, monthly billing statement, via your online account login, or by contacting your card or loan’s customer service department.
2. Divide your APR by 12: Take your APR and divide it by 12 (the total number of months in any given calendar year) to quickly identify your card or loan’s monthly APR.
3. Calculate your monthly interest: Next, take your outstanding account balance and multiply it by your monthly rate to determine how much that you owe your lender in interest payments for the month. 

How To Calculate APR On A Personal Loan

For a personal loan, you can start by determining the total interest charges on your personal loan. Then add any loan fees or charges to this amount. Afterward, divide this number by your principal balance (the amount you borrowed originally) – then, take this resulting figure and divide it by the total number of days in the loan’s term. Following this, multiply the result by 365 to calculate your annual rate, and multiply the subsequent number by 100 to express your annual rate in percentage form.

How To Calculate APR On A Mortgage

Start by adding up the total interest paid and any additional fees on your home mortgage loan. Next, divide this figure by the total amount of your loan – then take the result and divide it by the total number of days in your mortgage loan’s term. Once done, you can multiply the resulting figure by 365 to calculate your annual rate – then multiply that number by 100 to express the result as a percentage.

How To Calculate APR On A Credit Card

The formula for calculating the APR on a credit card is [Daily Rate] x [Average Daily Balance] x [Number of Days in Billing Cycle]. To calculate your daily rate, you can divide your APR by 365. Your average daily balance can be determined by dividing your total credit card balance in a billing cycle by the number of days in the cycle. As for the number of days in your billing cycle, your billing statement or loan agreement should provide this information.

How APR Impacts You

Your APR impacts your total cost of credit or loan ownership – and how much you’ll be paying in fees and charges each month. You can avoid getting hit with unwanted interest payments by paying off your credit card balance each month, reducing interest by making extra loan payments, or transferring a balance to a new credit facility in exchange for a promotional APR.

Keep in mind that financial institutions such as banks, mortgage lenders and credit card companies determine your interest rates by weighing a number of different variables and factors. For instance – prospective lenders will take a close look at your credit score, which offers a snapshot of your purported creditworthiness, and credit history. Individuals with higher credit scores not only enjoy greater access to a wider variety of lenders and lending products, but also generally lower interest rates and APR, as this indicator signifies that they may present lenders with lower risk profiles.

A loan or credit card issuer will also review and consider current market conditions as well as the type of financial product and lending arrangement that is being offered. By evaluating these factors, financial institutions set a tailored APR for each consumer.

Annual Percentage Rate FAQs

Answers to several of the most frequently asked questions (FAQs) surrounding APR can be found below.

How do lenders determine APR?

Lenders determine APR by examining a number of different variables and overall market conditions. Credit card and loan providers will take a detailed look at your credit score and history. After cross-referencing them with current market conditions and the terms and conditions of the individual financial product being requested, you’ll be assigned an individual APR.

How do I check my credit card’s APR?

This information can typically be found on your credit card paperwork and monthly statement. You may be able to login online and access it from your account portal. Or, if preferred, you may contact your credit card provider via phone, email, or physical mail to obtain it as well.

Can I lower my credit card’s APR?

It depends. By improving your credit score and credit history, you may be able to secure a lower APR. You may also be able to shop around for another financial institution that’s willing to offer a more competitive rate or negotiate with your current provider. You can also port any outstanding balances over to another credit card that offers a lower promotional rate. In short, several options are available.

What’s a good APR?

That depends on the type of financial product you’re requesting and current market conditions. To get a sense of whether you’re being offered a competitive APR, it’s important to shop around and consult with a variety of financial providers. Keep in mind that your credit score will play a role in the APR you’re offered – any improvements to your score may garner you a better rate in the future.

The Bottom Line: Understand APR Before Applying For Financing 

Knowing what your APR can be critically important, and it provides a sense of just how much you’re paying annually for access to a credit card or loan product. APR can be both fixed or variable, but it’s not always locked in for life. You may be able to change it by shopping around for different financial products, negotiating with vendors, and capitalizing on promotional opportunities.

As a general rule of thumb, maintaining a better credit score and history if on time payments can improve your chances of securing a good APR and minimizing total cost of credit card or loan ownership. Keep in mind that it’s important to pay credit card and loan balances on time to avoid damaging your credit as well.

Interested in getting a closer look at your finances? Be sure to sign up today for the Rocket Money^SM app today!