APR, or annual percentage rate, is a crucial number that illustrates the overall cost of borrowing money from a lender. When seeking financing, it’s essential to grasp how to compute APRs and use this knowledge for comparing offers from various lenders and credit card issuers. Here’s a detailed explanation of how APR works for credit cards and installment loans.
Credit Card APR
The card issuer charges your credit card annual percentage rate when you carry a balance, meaning you don’t pay off your full balance each month.
It’s essential to know that the credit card APR doesn’t cover annual fees or other card-related charges.
Your creditworthiness significantly influences your credit card APR. Some issuers provide the same APR to all approved customers, while others tailor it based on your perceived risk as a borrower.
To calculate daily interest on your credit card, divide your APR by either 365 or 360 days a year (refer to your cardholder agreement for the method).
For example, with a 20% APR, your daily interest rate is about 0.055%. If you have a $1,000 balance on day one of your statement, it grows to $1,000.55 by the end of the day. Without additional purchases on day two, it rises to $1,001.10 due to daily compounding interest, continuing until the statement period ends.
Installment Loan APR
In an installment loan, the annual percentage rate incorporates not only the interest charged but also any associated fees and costs. Your creditworthiness plays a crucial role in determining the interest rate for the loan.
For instance, a mortgage APR may include points, which represent fees paid to lenders at closing in exchange for a lower interest rate. Lender fees and additional charges necessary to secure the loan are also considered in the loan’s APR. Some auto loan APRs may even include compensation for the dealership handling the financing.
Some personal loans have origination fees, deducted from your loan amount upfront. This makes a loan’s APR higher than the stated interest rate. The actual APR calculation varies based on the loan type and included costs.
APR vs. APY
It’s crucial to distinguish between APR (annual percentage rate) and APY (annual percentage yield). While APR reveals the cost of borrowing, APY is employed by banks and credit unions to illustrate the interest earned on deposit accounts. These two metrics serve different purposes in the world of finance.