What You Need to Know About APR

Annual Percentage Rates (APR’s) are best suited as a financial tool to be used when shopping for a loan or mortgage. An APR reflects fees, costs, and interest rates. Keep reading to learn how the annual percentage rate measures the true cost of a loan.

Annual Percentage Rates provide an in-depth financial perspective than interest rates. If they are not properly analyzed, an APR can be a misleading financial concept. Lenders have different options to choose which fees to include in their APR calculations and have the option to omit others. The cost of a loan changes from lender to lender which reduces the reliability of the APR calculation as a comparison tool.

Why Does the APR Fluctuate?

There are several factors that impact the movement of an Annual Percentage Rate. The following factors impact how the annual percentage rate measures the true cost of a loan.

  • The type of loan or product: certain loans have more expensive fees. Loans that are collateralized have demonstrated to be less risky to lenders. Borrowers tend to pay their secured loans before the unsecured loans.
  • The borrower’s credit history: a borrower’s credit worthiness is defined by their credit profile. Those that show they are able to pay their debts on time will received low APRs on future loans.
  • The borrower’s loan payment ratios: comparing the loan’s payment to the borrower’s monthly income calculates the borrower’s debt ratios. The lower your debt ratio is the less risk there is for the borrower.

Details to Understand About Annual Percentage Rates

It is important to understand a few things about the concept of the APR.

APR’s and Credit Cards

The Annual Percentage Rate shows the interest rate a credit card user will pay. The APR calculation for credit cards exclude compounding interest. Those who make the minimum payments each month, will be paying interest on interest eventually (this is known as compounding) and should be avoided at all costs. Compounding interest can increase the cost of borrowing.

When researching a credit card, you need to compare lender fees separately. How you plan to use the credit card will sometimes be the deciding factor when comparing the APRs. There are times where a credit card will also have multiple APRs depending on the transaction or balance transfer.

APR’s and Mortgage Loans

The Annual Percentage Rate is more complex from a mortgage perspective because the APR includes the interest charges plus the costs. A borrower needs to evaluate the APR and the specific issues that are associated with mortgages.

Repaying Loans Impact on the APR

The length of time you are intending to use the loan is important. The Annual Percentage Rate calculates the loan costs over the life of the loan so if you want to keep the loan for a short amount of time, the APR is higher.