What Is APR: What Does Annual Percentage Rate Mean?
APR is a term that’s used when discussing credit products like credit cards, automobile loans, or mortgages, but what does annual percentage rate mean, exactly? In short, this rate determines the cost of credit for a year. The process is standardized across the financial industry and the information will allow you to compare individual products (like a credit card or mortgage) from various lenders before you make your decision.
How Does APR Work?
APR can be applied to a variety of different loans and credit cards. For example, if you have a credit card and you do not pay the outstanding balance for your purchases in full by the due date, the specified annual percentage rate (APR) will be applied to the balance going forward.
How Is APR Calculated?
The APR may be fixed or variable for credit cards or auto, personal and home loans. Most credit card issuers base their variable rate on the U.S. Prime Rate with an additional margin applied. While the margin will most likely remain the same during the course of the borrowing, the APR may change if the Prime Rate fluctuates because your margin and the Prime Rate determine your rate overall.
How to Calculate How Much Interest You Owe
Financial institutions use a very precise formula to calculate how much interest you will pay. In the case of a credit card, this is often governed by the daily periodic rate which equals the APR divided by the number of days in the year. This ratio will then be applied to the outstanding balance for the number of days in the billing period to determine how much you owe. Some financial institutions use different methods to calculate interest.
Types of APRs for Credit Cards
There are different types of APRs that may apply depending upon how you use your credit card. How you use your card and how quickly you pay off your balance can both affect the amount of interest on your card, so it’s important to keep up with your payments. The APR options will vary based on both the card and the financial institution. For example, at Huntington, you can choose to earn rewards or a lower APR on a Voice Credit Card®.
The types of APR include:
1. Purchase APR
The purchase APR is the interest rate that applies to purchases of goods or services with your card. Some cards enable you to avoid incurring interest on purchases by paying the balance on your credit card each month.
2. Cash Advance APR
The cash advance APR is the interest rate that applies if you use your credit card to get a cash advance, for example from an ATM or teller. The cash advance APR often is higher than the purchase APR and interest may begin to accrue on the cash advance immediately without any grace period.
3. Balance Transfer APR
The balance transfer APR is the interest rate that applies if you use your credit card to pay off a debt with another creditor. Transferring a balance to a lower rate credit card might save you money depending upon the applicable fees.
4. Penalty APR
Some lenders use a penalty APR to encourage borrowers to stay within the terms of their agreement. This is typically the highest rate of all and can be applied to balances on the account if you fail to make required payments within 60 days after they are due and you do not thereafter make timely payments in the manner disclosed by the financial institution. This can increase the cost of borrowing for the remainder of the agreement.
5. Introductory APR
Sometimes, lenders will offer a lower “introductory” or “promotional” APR on a credit card for a certain amount of time. Be sure to check the regular APRs to make sure you are comfortable paying interest at the regular rates when the introductory period ends.
APR vs Interest Rate
Some people think that the terms “APR” and “interest rate” are one and the same thing. However, the APR for closed-end credit (like a mortgage loan) may include other items such as certain closing costs. Once you understand what APR means, you can make better-informed decisions to help you manage your finances.