It's one of those terms you see everywhere - from billboards, to bank windows, to the bottom of the ads on your favorite website. Just three little letters, APR. Yet if you're borrowing money, they're important ones.
Understanding what this acronym means and learning how to use an APR calculator makes it easier to compare rates and offers when shopping for credit cards, loans, credit lines, and mortgages. Here are the basics of what you need to know about APRs and their calculations to make wiser financial decisions.
What is APR?
APR stands for Annual Percentage Rate. In simple terms, this is the total cost of borrowing, including interest, fees, charges, and points, expressed as a yearly percentage rate. The federal Truth In Lending Law requires lenders to tell borrowers the rate during the loan application process, as well as the total dollar cost of financing.
This is because what may seem like a great low interest rate deal may actually cost borrowers more than they expected once all the additional fees and charges are factored in. Knowing the APR makes it easier to compare different loans, as it accounts for extra costs associated with each lending offer.
Why You Should Pay Attention to APR
Understanding the calculation behind the annual rate helps borrows ensure that the rate the lender quotes them accurately reflects their actual total cost of borrowing. This is especially important for mortgages, loans, and credit lines which require regular monthly, bi-weekly, or weekly payments on an outstanding balance, because interest accrues on that balance. It's also key for credit card borrowing if you plan to carry a balance on your card.
Once you have the true annual percentage rate of each offer, (which includes the finance charges and any extra processing or application fees), you'll be better able to compare offers which may have different charges, fees, and rates.
Mortgages, Adjustable Rate Mortgages, Credit Cards, and APR
To make life just a little more interesting, the posted rates you may see advertised for different types of credit aren't all calculated the same way. With mortgages, for example, the APR is different from the posted mortgage interest rate because it takes into account the extra costs of the mortgage, such as points, mortgage broker fees, or other charges that come with the mortgage. Yet if you're reviewing two or more adjustable rate mortgage loans (ARMs) where the rate may change during the loan term, or an ARM against a fixed rate mortgage, be cautious about using an APR calculator to compare rates between competing offers. An APR doesn't account for the maximum rate you may be charged for an ARM.
Comparing credit card offers may seem much simpler. This is because when it comes to credit cards, the advertised rate is usually the APR.
How to Figure Out Your APR
If you really want to, you can figure out the APR of your loan, fixed rate mortgage, credit card or other credit accounts as long as you have all the information needed. Here's how.
- Divide the annual interest rate by twelve (or the number of compounding periods within one year). So if the annual rate is 6 percent divided by 12 months, you now have what's called a nominal interest rate of 0.5 percent per month.
- Use the formula [(1 + monthly nominal interest rate/12)^12]-1 to calculate what is known as the effective interest rate. [(1 + 0.5/12)^12]-1=6.17 percent.
- Add any additional fees or charges divided by the original loan amount. So for example, for a $10,000 with a $150 processing fee, the APR would be 6.17 percent + 1.5 percent (from $150/$10,000) = 7.67 percent.
Use an APR Calculator Instead
The good news is there's no need to pull out your calculator (or pencil and paper) to figure out APRs on your own. Sometimes finding your annual rate may be as easy as reading through the fine print in your loan agreement, or simply looking at the posted offer. You can set up a My LendingTree account which can potentially save you money by offering cards with lower interest rates. It is especially important to closely examine and compare APRs on credit card offers, especially those with introductory teaser rates. Whether you're looking at mortgages, personal loans, credit lines, auto loans, small business loans, credit cards, or student loans, My LendingTree will help you calculate rates and show you the best offers for your financial situation.