What Is APR and Why Does It Matter? 

The annual percentage rate (APR) on a loan or credit card is a crucial term to know because it directly impacts how much you’ll pay for borrowing money.

APR sounds similar to APY (which stands for annual percentage yield), but they're very different. APR is important from a borrower’s perspective, while APY is important from a saver’s perspective.

What Is APR?

APR includes not only the interest rate lenders charge but also any other fees or closing costs that might be part of a loan.

Whenever you apply for credit, the lender must disclose the APR so that you know how much it will cost you to borrow the funds. This is law under the Truth in Lending Act (TILA).

APR vs. APY

You’ll see both APR and APY in your banking, but the terms affect your finances in very different ways.

• APR is the rate you'll pay on any money you borrow through a loan or credit account.
• APY indicates how much interest you’ll earn on investment products. 

When you're researching savings accounts or investment products, look for a high APY so you can earn more. When you're comparing loans and credit cards, look for a low APR so you can pay less.

Fixed vs. variable APR

Lenders will offer you either a fixed or variable APR.

• A fixed APR generally stays the same for the life of the loan. If you have a fixed APR credit card, your issuer is required to provide notice 45 days before increasing your interest rate or changing any other fees associated with your account.
• A variable APR fluctuates with the market. For example, if your account is linked to the prime rate, when the prime rate increases, your loan provider will also raise your APR.

There are pros and cons to both. A variable APR is risky because it can increase if the market rate goes up. But if you get a fixed APR while interest rates are high and they then drop, you could be locked into a higher-than-market rate.

With credit cards, you’ll typically see variable APRs that can change often.

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Types of Credit Card APRs

You might not realize that your credit card's APR doesn't stay the same for all types of transactions.

Here are the different types of APRs you may be charged:

• Purchase APR is the rate you'll be charged most often. Note that interest on new purchases doesn’t start to accrue until after a grace period, which is usually 21 days — so if you pay your balance off each month, you won't be charged interest.

• Balance transfer APR is the rate you'll pay to transfer debt from one credit card to another. Card issuers often offer limited-time 0% APR promotions on balance transfers to encourage you to switch your account to them.

• Cash advance APR is what you'll be charged to withdraw cash from your credit card. This is usually a high rate, in part due to there being no grace period.

• Penalty APR is what you'll be charged for missing two consecutive payments or being 60 days late on your payment. Your APR will go up as high as 29.99% and usually won’t decrease until you’ve made at least six months of on-time payments. You could also face a ding to your credit score.

When you’re choosing a new credit card, be aware of the different APRs. Most of us focus on the APR for purchases, but it’s important to also know how much you'll be charged for balance transfers and cash advances. 

If you’re opening up a card expressly for a balance transfer to pay off debt sooner, pay attention to how long that introductory rate lasts. Make a plan to pay off the balance in full within that time to avoid the shock of a higher APR.

READ MORE: How Does APR Work on a Credit Card?

Factors Affecting Your Annual Percentage Rate

One of the major factors that will impact your APR is your credit score. This is a number ranging from 300 to 850 that represents your creditworthiness.

The higher your credit score, the better. You'll get more competitive APR offers with a strong score.

Other factors impacting APR include the current prime rate, your income and debts, and the type of loan you’re applying for. 

For example, credit cards tend to have very high APRs (in the 20%+ range), while personal loans and mortgages are much lower (around 12% and 6%, respectively). Stay away from predatory payday loans, which can charge sky-high APRs.

RELATED: How To Increase Your Credit Score the Right Way

FAQs

TL;DR: Why APR Is Important

APR is the total cost of borrowing money, including interest and fees. Always look for the lowest APR possible when comparing loans or credit cards — otherwise, it could cost you a lot to borrow.

You may be able to lower your APR by improving your credit score through on-time payments and paying off your debts in full. You can also try calling your lender or card issuer to negotiate a lower rate.