Americans hold almost $178 billion in unsecured personal loans right now. Historically low interest rates in recent years have made them good deals for anyone looking to consolidate debt or cover surprise expenses.
But interest rates aren’t the full picture as to what is a good deal for a loan. For that, you have to look at the APR or annual percentage rate. You might have already run across it when doing your loan homework, but still wonder exactly what is an APR and do you really need to worry about it.
APR is used across a lot of financial products as it helps you see at a glance the total cost of a particular loan. It’s good to know what goes into setting the APR and how you might get a better rate on your loan. Let’s look at what the APR is and how to calculate it.
Put simply, the APR tells you the overall cost of the loan as a percentage. It takes into account how much money you have to pay back in total based on the loan terms to show your actual yearly cost.
This standardized measurement is used in the industry to help you make an apples-to-apples comparison across loans and lenders when the terms differ. It includes any fees and other costs for the transaction along with the interest and principal payments. You get a bottom-line number that makes it easier to compare among credit cards or loan products.
The lender or credit card issuer has to tell you the APR before you can sign the agreement. For personal loans, the APR includes the interest rate plus origination and other fees calculated on a yearly basis. If the loan has no fees, the APR and the interest rate are the same.
It’s worth noting that you still should look closely at the entire package and not just the APR. Lenders are only required to include compulsory charges in the APR, so there could be fees not included that make the APR look more attractive than it truly is.
When there aren’t any fees for the loan, the APR would be the same as the interest rate. But most loans include an origination fee of 1 to 10 percent of the total loan amount. That fee doesn’t change the interest rate, but it does change the total cost of the loan.
The APR tells you how much money you have to pay back in total, while the interest rate shows how much you have to pay back in a single year. Your interest rate has a stronger impact on the monthly payment amount, so there might be times when a higher APR might be a better option for you.
Generally, the APR tends to be higher than the interest rate since it includes all the loan costs.
The APR is expressed as a percentage and involves several factors. The formula adds the fees to the total interest paid over the life of the loans and the principal or loan amount. That number is then divided by the number of days in the loan term.
To annualize the rate, you then multiply by 365, then multiply by 100 to get the APR.
As you can see from the formula, the APR is impacted by the
You can talk to two lenders who charge different origination fees and have slightly different interest rates. The APR helps you compare the two to see which is the best deal.
A loan with a lower APR can have a higher monthly payment because the loan length is less. But the cost in the end is less than if you had a higher APR and a lower monthly payment.
Pulling in so many factors to set the APR makes it easier to compare the true cost of a product like an emergency loan. Overall, the best APR is the lowest you can get as long as you can manage other terms of the loan. If a low APR makes the monthly payment more than you can budget for, it’s not a good APR for you.
The APR for a personal loan can run from 6 percent up to 36 percent. The rate is impacted by the interest rate, which has been dropping to an average of 8.73 percent for a 24-month loan. For credit cards, interest rates run 15-16 percent.
The larger the loan, the lower your APR tends to be. It will also go lower if you have a good credit score and history along with decent cash reserves.
Keep in mind that some finance companies advertise really low APRs to get you in the door. But make sure you check the fine print as that nice intro APR can turn into a much higher one within a few months.
The rule of thumb for the best APR is one that falls below the average rate of return in the stock market—usually around 5 percent. That way, you earn more on your investments than you’re paying in interest. It’s not easy to qualify for that low of a rate, however.
When you take out a loan, it’s important to understand just how much that loan will cost you overall. Your interest rate is important but only tells you how much it costs to borrow the money and not all the associated costs. The APR is an important tool to help you compare costs across lenders when interest rates, fees, and payment terms differ.
Still have questions about what is an APR? Our blog is full of information and advice related to loans and interest rates to help you understand the fine print of your debt.