The terms “APR” and “interest” are often used interchangeably in casual conversation, but they’re actually different on paper when you get down to the numbers. It’s important to know the difference between APR and interest.
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Interest is a fairly straightforward concept, reflecting the annual cost of borrowing the principal balance on a loan.
APR — or annual percentage rate — gets trickier. It often includes fees charged in association with the loan and is designed to reflect the total cost of the loan over time. With credit cards, which operate as short-term loans, it’s used to calculate interest that accumulates daily.
More Than One APR
Different lenders have different ways of calculating APR and, if you read the disclosure statements that come with a credit card, you may find several different APRs that are applied to different kinds of transactions, such as balance transfers. Be aware that there’s almost always a higher APR for cash advances than purchases. Also be aware that many credit cards begin with an introductory APR that changes to a higher APR after the introductory period ends.
What to Watch
There’s a lot of math that goes into calculating APR. The key thing to know is that APR is a more complete disclosure of the actual cost of credit.
- If you want to know the true cost of a loan over time, compare the APR on each credit arrangement.
- If you want to know which loan is going to have the lowest monthly payment, comparing interest rates is one component to consider.
The APR you will pay is almost always higher than the interest rate because it represents the total cost of the loan. So, you should always look at APR when comparing credit cards, car loans and mortgages because this is the actual price tag.
Who Regulates APR Disclosure?
The Truth in Lending Act of 1968, now enforced by the Consumer Financial Protection Bureau, sets forth requirements for the calculation and disclosure of APRs to make comparisons easier for consumers — all lenders have to provide it.
The idea behind the APR disclosure was to level a complex playing field where the elements of many different kinds of loans and credit agreements varied in many key areas, including transaction fees and interest rate structures. APR makes for even and accurate comparisons.
How Do I Get a Lower APR?
The APR you are charged is a reflection of your credit terms, and your credit terms depend on your credit history, your credit score, and other factors. Typically, the lower your credit score, the higher your APR. Over the long haul, if you build a favorable credit history, you may get a lower APR.
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How to Forget Everything You Just Read About APR
With credit cards, APR typically applies to unpaid balances. This is why financial experts say you should always pay the statement balance due at the end of each billing cycle — although you always have the option of paying a minimum balance due. There is a stretch of time, known as the “grace period,” lasting from the end of a billing period and the date your minimum payment is due. During this time, you can pay your credit card bill without paying interest on new purchases. However, if you make just the minimum payment, or even a partial payment that exceeds the minimum payment but is less than the entire balance, interest will be charged. Interest may also be charged when cash advances or balance transfers post to your account. See your cardmember agreement for specifics.
Carrying over a balance from month to month, however, becomes expensive. If you want to know how expensive, understand your APR.