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What is APR?

This post was featured at DebtFree-Revolution.

APR...that ubiquitous number you see all over your junk mail and credit card statements. Although it's often in the fine print, it has big meaning for your money.

APR, or Annual Percentage Rate, is the amount of interest, plus fees, that you are charged for borrowing money. The APR is a way to compare what it would cost you to borrow money from different lenders. It is often different than just the interest rate, and represents the true cost of borrowing that money.

This is where the APR gets really important. The APR is a reminder that spending money you don't have doesn't come cheap. For example, if you charge $1000 on your credit card this month, and don't repay that money within the grace period, you will be charged interest and fees. Let's suppose those interest and fees total an APR of 20%.

If you choose to only pay the minimum monthly payment, usually 4% of your bill, you are going to continue getting charged interest and fees on that borrowed money. If you continue to pay only the minimum payment each month, it will take you over 7 years to repay that $1000! In addition to taking so long to be free of that debt, you will have paid over $500 dollars in interest...more than half of what you borrowed in the first place!

Your APR suddenly seems very imporant, doesn't it?

Cheer up...there is one way to be able to ignore your APR altogether: pay your credit card balance in full each month. If you haven't borrowed any money at the end of the grace period, you can't be charged any interest. Brilliant! Your APR could be 237%, but you wouldn't be charged a dime as long as you paid your credit card off every month.

And a few more important points about APR:

  • Many credit cards offer low 'introductory' APRs. Be wary and read the fine print; the low rate will often jump to a high rate after a certain amount of time...sometimes as little as one month.

  • There may be different APRs for late payments, cash advances, or for charging lower or higher amounts on your card (tiered APRs). Check the fine print for information on these as well.

  • A good credit score will allow you to get a better APR, and a low credit score may stick you with sky-high rates.

  • Sometimes your APR can change. If your APR is fixed, you will receive notice before this happens, but a variable rate can change without warning.

If you owe money on your credit card, use this calculator to figure out how much it's costing you and how long you'll owe that debt. Knowledge is power, and knowing about APR will save you time and money.


Anonymous said...

When it comes to savings, is an APY similar to an APR? For instance my credit union has a money market interest rate of 3.92% and an APY of 4.00%. Which is the more important number to pay attention to?

The Simple Nickle said...

Hi anonymous,

That is a great question. APY stands for 'annual percentage yield' and is usually touted in money market ads (rather than the APR). Generally speaking, the APY is going to be greater than the APR when it comes to money markets, and so it's the more important number.

Here's why: The APR is just the rate of interest applied to whatever you have in the money market. If you have $100 dollars in your money market at an APR of 12%, you will get $12 added to your account as an interest payment for the year.

The trick with the APY is how often the interest is paid to you. If interest is paid annually, you will get the $12 dollars in interest at the end of the year. More commonly, though, interest in money markets is paid monthly, weekly, or daily.

Thus, if you have $100 in your account, after the first month you will get 1% interest (12% divided by 12 months), or $1. The next month, you will get 1% interest again...but this time it's 1% of $101, or an interest payment of $1.01. Make sense? Each month, the interest percentage is being paid on a greater and greater amount.

In your instance, your account's interest rate is 3.92%, but you'll acutally be earning 4.00% because of how often the interest is paid to you.

It's nice to be getting more than you expected, for a change, isn't it?