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What Does the Term APR Mean, and How Does It Function?

APR, or Annual Percentage Rate, is the interest you’ll pay on your mortgage annually, expressed as a percentage of the loan balance. It includes the interest rate plus other charges or fees. For example, if you have a $100,000 mortgage with a 4% interest rate, your annual interest expense would be $4,000 or $333 per month.

Your monthly mortgage payment is mostly interest in the early years of your loan, so your mortgage balance won’t decrease much even as you make payments. In the later years, your monthly payments will include more principal, so your mortgage balance will go down.

The APR is higher than the interest rate because it includes the fees charged by the lender, such as origination fees, and any discount points you paid to get a lower interest rate. The APR is a good way to compare the total cost of different loans.

How Is APR Calculated?

The APR includes:

  • The interest rate.
  • Any points or origination fees.
  • Any other fees that may apply

To calculate the APR, divide the interest rate by the number of days in the year, then multiply by the loan amount. This will give you the interest charge for one year. Add to this any points, origination fees, and any other fees they may charge, and you have the APR.

For example, let’s say you take out a $100,000 loan at an interest rate of 6%. The number of days in a year is 365. The interest charge for one year would be $6,000. If there are no other fees, the APR would be 6%.

However, if there are points or origination fees, they will increase the APR. For example, if 2 points, or $2,000, are charged at closing, the APR would be 8%.

The APR is a significant number to consider when taking out a loan. It will give you an idea of the actual cost of the loan and help you compare different loans.

APR vs. Annual Percentage Yield (APY)

The APR, or annual percentage rate, is the interest rate charged on loan, expressed as a percentage of the loan amount. The APY, or annual percentage yield, is the effective interest rate earned on an investment, expressed as a percentage of the amount invested.

The two rates are similar, but the key difference is that the APR includes the effect of compounding, while the APY does not. Compounding occurs when interest is earned on previously earned interest, so the effective interest rate is higher than the stated interest rate. 

For example, if a loan has an APR of 5%, that 5% is applied to the loan’s principal each year. The interest earned in the first year is added to the loan balance. In the second year, interest is charged on the new loan balance, which includes the interest earned in the first year. This results in an effective interest rate of 5.25% in the second year.

The APR considers compounding, so it is always higher than the APY. The APR is the more accurate measure of the true cost of borrowing, while the APY is a more precise measure of the actual return on investment.

Why Is the Annual Percentage Rate (APR) Disclosed?

When you’re considering taking out a loan, the first thing you want to know is how much it’s going to cost you. The annual percentage rate (APR) is the annualized interest rate you charge on loan. In other words, it’s the interest you pay each year, expressed as a percentage of the loan amount.

Federal law requires lenders to disclose the APR when they advertise loans. This allows you to compare the costs of different loans and choose the one that’s right for you.

The APR includes the interest rate and any fees charged as part of the loan. This makes it an accurate measure of the cost of borrowing. For example, a loan with a low-interest rate but high fees could have a higher APR than a loan with a higher interest rate but no fees.

When you’re comparing loans, be sure to look at the APR, not just the interest rate. The APR will give you a better idea of the actual cost of borrowing.

What Is a Good APR?

The APR is the best way to compare different loans because it considers all borrowing costs. A good APR is lower than the average APR for loans of the same type.

You must shop around and compare offers from different lenders to get a good APR. It is also essential to have good credit to qualify for the best rates. You can get a free copy of your credit report from each of the three major credit bureaus every year.

If you are looking for a loan, ask about the APR and compare it to other offers you may receive. A lower APR can save you a lot of money over the life of the loan.

Fixed APR vs. Variable APR, What is The Difference?

There are two main types of APR: fixed and variable. As their names suggest, the main difference between the two is that a fixed APR stays the same throughout the life of the loan, while a variable APR can change.

A fixed APR is often preferable for borrowers because it provides stability and predictability. You’ll always know how much your monthly payments will be, making it easier to budget. When you take out the loan, a fixed APR may be lower than a variable APR.

However, a variable APR can also have its advantages. For one, it may start lower than a fixed APR and then increase over time, meaning you’ll save money in the short term. Additionally, a variable APR can sometimes offer discounts or other perks that a fixed APR doesn’t.

Ultimately, the best type of APR for you depends on your circumstances. A fixed APR is probably the way to go if you prefer predictability and stability. However, if you’re willing to take a bit of a risk for the potential of lower payments, a variable APR may be the better option.

What Are the Different Types of APRs?

Introductory or Promotional APR:

This is the lowest possible APR offered by the lender. If you don’t qualify for this type of APR, you won’t be able to get the loan.

Penalty APR:

This APR applies only if you miss a payment or make an incomplete payment. It’s designed to encourage prompt repayment so the lender can avoid having to charge additional fees.

Cash Advance APR:

This APR is typically used for payday loans, car title loans, and some personal loans. The APR is usually higher than the introductory APR because it covers the upfront cash advance fee.

Purchase APR:

This is what most people think of when they hear “APR.” It’s the amount you pay per month on loan.

It’s calculated by dividing the total amount borrowed by the number of months in the loan. So, if you borrow $1,000 for 30 months, your purchase APR would be 30/360 .

It’s not necessarily bad to have a high purchase APR. Many consumers choose to finance large purchases like cars with a high purchase APR because it makes the overall cost of funding more affordable.

Jason Rathman