What is an APR?
Annual Percentage Rate (APR) is the total yearly cost of borrowing from a lender – either for a credit card or an installment loan. It does not include the annual compound interest.
With credit cards, the APR is the interest rate charged by the credit card company only when you don’t pay off your entire balance each month. The annual and other fees you are charged to use the credit card are not the same as the APR. With an installment loan, interest rates, fees, and other costs are all included in the APR.
Types of APR
There are several types of APR, they include:
- Purchase APRs apply to your credit card purchases.
- Balance transfer APRs are applied when you transfer your balance from one credit card to another. You’ll pay this APR on that transfer portion. It is generally the same as a purchase APR.
- Promotional APRs are usually offered by credit cards to attract new users. Some credit cards offer lower APRs or even 0% APR for the initial year before you are charged the typical rate.
- Cash advance APR is charged on the cash you withdraw from an ATM with your credit card.
- Penalty APRs are charged on late payments. This is higher than the regular APR the company usually charges.
- Fixed APRs are applied on loans and remain constant throughout the life of the loan.
- Variable credit card APRs depend on the market interest rates and can increase over time.
What factors decide your APR
The factors that decide your APR vary depending on the type of loan you are applying for, but some of the most common factors include:
Credit score: APRs are unique to each individual’s credit history. Lenders charge people with lower credit scores higher APRs because they are considered risky borrowers. The chances of such borrowers missing or making late payments are likely higher.
Income: Your debt-to-income (DTI) ratio or the ratio of your monthly debt to your gross monthly income needs to be low to qualify for low interest rates. A high DTI means that you owe more than you earn. This is considered risky by lenders.
Prime Rate: This is the interest rate banks charge their most creditworthy customers. It is influenced by the federal funds rate, which is the interest rate that banks charge each other for overnight loans. When the federal funds rate goes up, the prime rate typically goes up as well. This is because banks need to make a profit on the loans they make, so they will charge their customers a higher interest rate if the cost of borrowing money is higher.
Loan type: Some loans like mortgage or auto loans generally have lower APRs because your home or car is used as collateral. Other unsecured loans, credit cards, and personal loans charge higher APRs.
To qualify for lower APRs on credit cards, having a good credit score, avoiding cash advances, and keeping your DTI low are some factors that may help.
