The financial world is full of lookalike acronyms—APR and APY among them. But there’s a big difference between an annual percentage yield (APY)—aka how much you earn in interest—and an annual percentage rate (APR), which represents how much you pay to borrow money. Learn more here about what APR is, how it’s calculated, and its impacts on different borrowing products.
What is APR?
APR is an interest rate that represents your annual borrowing costs for a loan or line of credit. APRs are everywhere, from car financing to credit card offers. Understanding APR could potentially help you save money.
Say you’re buying a new car and are torn between 2 models, each costing $24,000. However, one car has 1.9% APR financing for 60 months, and the other has 2.9% financing for 60 months.
| 60-month term | 60-month term | |
| APR | 1.9% | 2.9% |
| Monthly payment | $419.62 | $430.18 |
| Total interest cost for the life of the loan | $1,177.03 | $1,810.97 |
While a 1 percentage point difference between the 2 APRs might not sound like a lot, the higher APR will cost you over $600 more over the life of your loan. This information could help you decide which car to buy and which loan to take. Federal law requires lenders to disclose your APR before you sign on the bottom line.
What is a good APR?
A good APR depends on the loan type. For instance, a good APR on a car loan or mortgage might be much lower than a good APR on a credit card. That’s because auto loans and mortgages are secured by collateral: the car or home. If you default on your loan, your lender can take the collateral to make themselves whole. Since that lowers a lender’s risk of losing money, they offer you a lower APR.
On the other hand, credit cards and many personal loans are unsecured. Without collateral backing them, the lender assumes a higher risk. Therefore, unsecured loans and lines of credit generally have higher APRs.
No matter the credit product, your APR is typically tied to your creditworthiness. Have a high credit score? Lenders are more likely to reward you with a lower APR. A lower score, though, generally translates to higher APRs, since lenders view you as a higher risk for defaulting on your credit obligations. In any case, compare APRs for the same product before committing.
APR formula and how to calculate APR
The APR formula is:
APR = (((interest + fees / principal or loan amount) / number of days) x 365) x 100
Interest: The total interest paid for the life of the loan
Fees: These can include any additional administrative fees and other charges lenders tack on
Principal: The total amount borrowed
Number of days: The number of days in the loan term
You don’t need to do the math yourself. You can use an online calculator to determine total loan costs and compare loans with different APRs.
APR calculations for installment loans
Fees could significantly affect the APR calculation for an installment loan, like a car loan or mortgage, so be sure to add them all in. Potential fees could include:
Mortgages
- Points: Fees paid at closing to your lender to lower your interest rate
- Origination fees: Lender fees for processing your loan
- Private mortgage insurance (PMI): A type of insurance sometimes required on conventional mortgages if your down payment is less than 20% of the home’s purchase price
Auto loans
- Dealer fees: Charges from the dealership related to processing your loan or costs to get your car to their lot
- Add-ons: If you buy an extended warranty or service plan, these fees could get tacked onto your loan balance
APR calculations for credit cards
Banks usually calculate APRs on credit cards using as a starting point what’s known as the US prime rate—a baseline rate tied to (but higher than) the Federal Reserve’s benchmark federal funds rate. Large, reliable corporations might get an interest rate closer to the US prime rate than an individual might.
While some credit cards have fixed APRs that don’t change with the fluctuating prime rate, others have variable APRs. With those, if the prime rate climbs, your card’s APR might also increase.
Types of APRs
Loans and credit cards come with different types of APRs. Some of the most common include:
- Fixed APRs are locked in for the life of your loan.
- Variable APRs can change in response to market interest rates, which is typical with credit cards and adjustable-rate mortgages.
- Purchase APRs apply to a purchase made on a credit card if you don’t pay off the balance by the deadline.
- Promotional/introductory APRs are typically for new credit cardholders for a fixed rate and term. These tend to be lower than the usual APR for your credit card and can even be 0% for a time.
- Balance transfer APRs apply to balances moved from one credit card to another. These also can be as low as 0%, but they could be higher than your standard APR too.
- Cash advance APRs apply to cash borrowed from your credit card account and withdrawn from a bank or ATM. These tend to be higher than your standard APR.
- Penalty APRs may be applied to your account balance if you fall behind on payments. These also tend to be higher than your standard APR.
APR vs. interest rate
When you look at APR vs. interest rate, they’re both percentages. However, your interest rate and APR are different numbers. While your APR includes all fees related to your loan, your interest rate does not. That’s why the APR is usually higher than the interest rate on the same loan or line of credit.
APR vs. APY
The key to understanding the difference between APR vs. APY is a short and sweet explanation: You pay an APR, but an APY pays you.
APR is the total annual interest you pay to a lender on a loan or credit card, including fees.
Annual percentage yield (APY) is the rate of return you earn on an investment or bank account, including compound interest, over the course of a year.
APR and you
You can take steps to improve your chances of scoring a lower APR, thereby reducing your borrowing costs. These include:
Clean up your credit
A healthy credit report could translate to a higher credit score and better APRs. To improve your credit score, review your credit report annually for errors, dispute incorrect items, and stay current on payments. Here’s how to check your credit report and credit score.
Decrease your credit utilization
Lenders tend to prefer borrowers who use 30% or less of their total available credit. Take inventory of all your credit cards and take steps to pay off debt until your balance is 30% or less of your total credit limit.
Shop around
You don’t have to automatically accept the first APR offer. Instead, compare different lenders and credit card or loan offers to find the features and APR that make the most sense for you.