What is Annual Percentage Rate (APR)?

Annual percentage rate, commonly referred to as APR, is a numeric representation of your interest rate for a whole year. When deciding between different types of loans, APR can help you compare options and find the least expensive solution. Depending on your loan agreement, your rate may be variable and change with certain fluctuations in the market or it may be non-variable and stay the same throughout the duration of your loan (fixed rate).

Many people often confuse the advertised interest rate with the loan's APR, so it's important to make a distinction between the two. The interest rate, expressed as a percentage, is the annual cost of a loan, but does not include any type of associated fees. The APR, also expressed as a percentage, is the annual cost of a loan including fees. Common fees include insurance, loan origination fees, or closing costs (when referring to a mortgage loan).

Standardized APR Computation

Every consumer loan agreement must disclose the APR, as outlined by the Federal Truth in Lending Act. Since all lenders are required to follow the same rules when it comes to the accuracy of the APR, it is often the most reliable basis for comparing the cost of various loans. The purpose of the APR is to give you more information about how much you are really paying when you take out a loan. If you are deciding between two different loans, a fair comparison includes an examination of both APRs. It's also helpful to compare actual interest rates, because your monthly payment is based on the interest rate outlined on the promissory note - not the APR.

With so many factors influencing the cost of a loan, including transaction fees, interest-rate structure, and late payment penalties, the standardized APR computation is particularly helpful. The APR is a bottom-line number that can easily be used to compare one loan offer to another. Since loan issuers must show potential borrowers the APR in order to provide a clear understanding of the actual price they will need to pay, it is important to check the percentage rate prior to signing on the dotted line.

The 0% APR Mirage

If you are in the market for a credit card or car loan, you have probably heard companies advertise 0% APR for an introductory period. Although this sounds like an attractive deal, like most things that sound overly enticing, there's a catch. You can avoid paying finance charges for the introductory period, but only if you pay off your balance in full before the designated period. If you fail to pay in full, you will be charged interest on the remaining balance. Plus, if you are late on your payment during the introductory period, the 0% APR goes out the window and you will be stuck having to pay the regular APR.

Only a select few are eligible for 0% APR offers, because you must have extremely good credit and in the case of a car loan, a sizeable down payment. If you are eligible and know you can make your payments on time each month, then by all means take advantage of a nonexistent APR.

As is the case with any financial decision, consumers must do their homework and equip themselves with the most up-to-date information. It's no surprise that borrowing money can be expensive, because a lender will always want some sort of compensation in return. Compare APRs in order to find the best deal for your individual situation and borrow with confidence.