How To Calculate APR In 3 Steps

If you’re looking at credit card offers or shopping for an auto loan, mortgage or personal loan, you’ll likely hear the term APR. It stands for annual percentage rate and is the cost you’ll pay for borrowing money, including interest and fees.

Although a lower interest rate can help ensure a lower APR, it isn’t the only factor. Read on to learn why understanding APR is so helpful for effective financial planning, comparing credit cards or loan offers, and knowing how much you’ll pay over a loan term.

At A Glance: 3 Steps To Calculate Monthly APR On A Credit Card

If you don’t pay your credit card balance in full each month, you’re likely paying interest charges on the loan amount plus fees. Most credit card companies compound interest daily and don’t use simple interest.

The Truth in Lending Act requires credit card issuers to disclose the APR, finance charges, late fees, and other critical terms to customers. Understanding this information on credit card interest and APR empowers you to make wise financial decisions regarding carrying a credit card balance and repayment. 

We’ll walk you through how to calculate the monthly APR using your credit card statements or other information. By crunching the numbers, you can understand the fees and interest you’re paying when you carry a credit card balance.

1. Determine the APR and Account Balance

Refer to your credit card agreement, monthly statements, online portal or contact the card's customer service to find the APR.

2. Divide the APR by 12

Divide your credit card’s APR by 12 (the number of months in a year) to get the monthly APR.

3. Determine Monthly Interest Charges

Finally, multiply the outstanding balance by the monthly rate to determine how much interest you owe for the month.

What Is APR?

APR is the cost of borrowing money and includes both the interest rate on the loan amount and additional fees charged by lenders. Also, APR It helps borrowers compare loan offers, with higher APR indicating higher borrowing costs. The APR calculation considers compounding interest and may include origination fees, providing a more comprehensive picture of the total loan expense.

Variable And Fixed APRs Explained

There are two types of APR: variable and fixed. A variable APR fluctuates with changes in the market, and is often tied to a benchmark like the prime rate. This means the interest rate can rise or fall on variable-rate loans, impacting monthly payments. When the benchmark is down, you’ll have a lower APR.

In contrast, a fixed APR remains constant throughout the loan term, offering stable and predictable monthly payments. Variable APRs may start lower than fixed APRs, but they carry the risk of increasing over time. Choosing between the two depends on your risk tolerance, financial stability, and current market conditions.

APR Vs. Interest Rate

The difference between APR and the interest rate relates to their scope. The interest rate solely reflects the interest charged for borrowing money and is expressed as a percentage. In contrast, APR encompasses both the interest rate and additional fees and charges. Thus, the loan’s APR gives you a clearer picture of the true expense associated with a loan. This information is helpful in making informed decisions and accurately comparing different loan offers.

How Financial Institutions Determine Your APR

Financial institutions, such as credit card companies, determine a consumer's APR based on several factors. Key elements include the consumer's credit score, which reflects their creditworthiness and credit history. A higher credit score often results in a lower interest rate and APR, as it signifies lower risk.

The credit card issuer also considers market conditions and the type of credit card being offered. By evaluating these factors, financial institutions set an appropriate APR for each consumer, reflecting their credit risk and ensuring their profitability.

The APR Equation

To calculate APR on loans or credit card debt, including fees, use the following formula: 

APR = ((Total Interest Paid + Total Fees / Principal or Loan amount) /

Number of days in loan term) x 365 x 100

Where:

• Total Interest Paid is the sum of all interest payments made over the loan term.
• Total Fees include any upfront fees, origination fees or other charges associated with the loan or credit card.
• Loan Amount is the principal amount borrowed.
• The result is expressed as a percentage.

APR Calculation FAQs

Let’s explore some of the common questions related to calculating APR for credit cards and loans.

How can I calculate APR?

To calculate APR:

1. Determine the total interest paid over the loan term or credit card billing cycle.
2. Add in any upfront fees, origination fees, or other charges associated with the loan or credit card.
3. Divide the interest and fees by the loan amount or credit card balance.
4. Divide this number by the number of days in the loan term.
5. Multiply the result by 365 and then multiply by 100 to get the APR as a percentage.

What’s the difference between APR and APY?

Although APR and APY seem similar, they are used in different types of applications. APR applies to loans, such as personal loans and credit cards. It represents the annual cost of borrowing, including interest and fees. On the other hand, APY is used for savings accounts and investments, representing the annual rate of return, including compound interest. While both provide valuable information, APY accounts for the compounding effect on savings, making it a more accurate measure for evaluating investment returns.

What is APR on a credit card?

APR on a credit card represents the total cost of borrowing on the credit card, including the interest rate and certain fees, and is an annual percentage. The APR helps you understand the true cost of carrying a balance on your credit card and allows you to compare different credit card offers.

How do lenders determine APR?

Lenders determine APR based primarily on your creditworthiness and the current market conditions. Your credit score plays a significant role, with higher scores generally resulting in lower APRs due to reduced perceived credit risk. Additionally, lenders consider the type of loan, prevailing interest rates, the loan's term and amount, and if there is collateral such as a home or car.

The Bottom Line On Calculating APR

Knowing how to calculate APR allows you to understand the true cost of borrowing on credit cards and loans. Understanding APR also allows you to effectively compare loan and credit card offers to make smart financial decisions.

Ensuring you have the best APR for your credit cards and loans is a great way to save money. Download the Rocket Money℠ app and turn those savings into an emergency fund automatically.