It’s important to know the APR and the interest rate when applying for a loan. Although you might find it difficult to differentiate between the two terms, they are distinct. If you are not aware of the difference, you could face higher monthly payments than expected.
Learning about interest rates is the perfect way to ensure having good savings. Keep reading to know more about what an APR is and how it differs from interest rates.
What Are Interest Rates?
When you take out a loan, in addition to the principal, you’ll be charged an 'interest'. The interest rate is denoted as a percent of the overall loan amount. Your lender will combine it with the principal to work out what monthly payments you’ll be required to make to repay the loan by the due date.
A daily interest formula derives the amount of interest getting accumulated on your loan each month. To get this figure, multiply your interest rate with the number obtained by multiplying your remaining loan amount with the number of days after your last payment.
What is APR? How Is It Calculated?
APR stands for annual percentage rate and it denotes your annual interest rate instead of a monthly charge. Your APR includes your interest rate and perhaps some additional charges such as document processing, guarantee, loan processing and application charges. These extra charges account for a loan’s usually somewhat higher APR than the publicized interest rate.
Consider the following example to know how to calculate an APR
If you borrow an amount of $100,000 with a 5 % interest rate, your annual interest would come to be $5,000. Let $3,000 be the fees incurred to you. Combining the fees to the mortgage amount yields $103,000, above which you’ll be paying an interest of $5,150 at 5 percent. The APR is calculated by dividing the annual interest amount ($5,150) by the principal loan amount ($100,000), resulting in an APR of 5.15 percent.
What Determines Your APR?
Lenders determine a loan’s APR using your credit score and it’s dependent on many factors including your credit history. Normally the lesser your credit score value, the higher the interest rate. Also, different APRs apply to different types of transactions.
The credit card companies and lenders, by law, must reveal the APR to customers to facilitate a proper understanding of the effective rates related to their agreements.
APR vs. Interest Rate
In order to clearly understand the terms, analyze the similarities and variations between an APR and interest rate. Once you know what they mean, you’ll be able to determine what you’ll actually be paying in interest, on both monthly and yearly basis.
- Both differ from lender to lender.
- Both can be applied to compare loans.
- Both are denoted as percentages.
- An APR includes fixed charges while an interest rate doesn't.
- An interest rate is normally lower than an APR.
- An interest rate reveals the prevailing cost of the loan amount but the APR equals the overall price over the duration of the loan.
APR and Credit Cards
Credit cards bear revolving liability and their interest is frequently compounded, which isn't included in APR. Search for the annual percentage yield (APY) when comparing credit cards to find the best deal because the APY indicates the overall amount of interest that will be required to be paid by you on an account. The APY is dependent on the interest rate and a 365-day compounding frequency.
When you’re fit to borrow money, do your research. Refer every loan and credit card contracts to know how much you are required to pay over the course of the loan and inquire about the terms you don’t understand. Make sure to have all the relevant facts with you to make a sound decision.
Good Credit Card APR
A good credit card APR is something that can be accessible to customers in the long term and falls within the scope of their paying capabilities. The rate of good credit card APR is forever going to be 0 percent which isn’t always practical. In general, cards with low-interest rate remaining close to 10%, but some products on the market are advertised with substantially lower rates.
You can’t merely trust an APR quote to estimate a loan. Instead, review every charge linked to your loan to find out if you’re receiving a good deal. If you’re comparing lenders, experts recommend that you understand the individual charges included in the quote to arrive at the best decision.
Also Read: 6 Ways to Get Your Free Credit Score in 2018