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What Is an Annual Percentage Rate (APR)? | APR vs. APY

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Highlights:

  • An annual percentage rate (APR) represents the total annual cost of borrowing money, represented as a percentage.
  • Comparing APRs across multiple loans or lenders can help you find the best options for your situation.
  • Annual percentage yield (APY) is similar to APR but refers to money earned in a savings account or other investment, rather than the interest rate paid on a loan.

You may have seen the term annual percentage rate (APR) while shopping for a credit card, mortgage, car loan or personal loan. An APR is a number that represents the total yearly cost of borrowing money, expressed as a percentage of the principal loan amount.

The APR on a loan or credit card aims to offer a complete picture of how much it costs to borrow money. So, the APR will be one of the most important numbers to consider when applying for new credit.

How does an APR work?

When you borrow money, you usually have to pay back the original amount plus an additional percentage of the loan amount as interest. Your interest rate varies depending on the type of loan you choose and your specific financial situation. The length of the loan, your credit score and other factors can all impact the amount of interest you pay.

An APR is your interest rate for an entire year, along with any costs or fees associated with your loan. That means an APR presents a more complete picture of what you'll pay for the loan each year. Comparing APRs across multiple loans or lenders can help you find the best options for your situation.

For credit cards, where interest is always expressed annually, the terms APR and interest rate are used interchangeably. A credit card APR does not typically include additional fees. It's also important to note that you can avoid paying interest on credit card purchases, provided you pay off your balance on time each month.

APR vs. interest rate

In the context of mortgage, auto, personal and other types of loans, the terms APR and interest rate are similar but not identical.

An interest rate is simply the price you pay to borrow money, expressed as a percentage, and does not include any additional fees related to the loan. Interest can be charged annually, monthly or even daily.

On the other hand, an APR represents your interest rate for the entire year. Plus, an APR includes additional costs attached to a loan. For example, on a mortgage, the APR will generally reflect not only the interest rate you're being charged but also any closing costs, origination fees, broker fees and other expenses associated with securing a loan.

When comparing loans side by side, an APR usually offers borrowers a fuller picture of the true costs than just the interest rate. For this reason, an APR will also usually be higher than an interest rate, though this isn't always the case.

Why is the APR important?

When it comes time to apply for new credit, it's wise to be aware of what the APR is and how it reflects what you'll pay over the life of the loan.

APRs are important because they can make it easier to compare lenders and loan options. Also, credit card companies are required to disclose the APR before issuing a card and on monthly statements.

What affects your APR?

The APR is determined by the lender or creditor. However, your credit scores can impact the rates you're offered. If potential lenders and creditors see a record of responsible credit behavior and consider you a low-risk borrower, you may receive a lower interest rate, which will generally lower the APR.

APR vs APY: What's the difference?

Although APR and APY may look and sound similar, the terms actually mean something entirely different:

  • APR represents the total yearly cost of borrowing money, expressed as a percentage, and includes the interest you pay on a loan.
  • APY refers to the total amount of money you earn on a savings account or other investment, taking into account compound interest.

Compound interest occurs when you earn interest not only on your principal savings balance, but also on any previous interest earnings. A standard interest rate on a savings account generally does not reflect compound interest. So, APY can be a helpful tool because it offers a more complete picture of how much your savings might grow over time.

Be sure to keep APY in mind when you're hunting for a new savings account or investment. Comparing the APY across different accounts can help you make the smartest choice possible for your financial life.

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