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Aug 6, 2023

What Is an Annual Percentage Rate?

Banking/Personal Finance, Credit Cards, General Information

What is APR?

man holding up car keysThe two terms that are often used interchangeably when talking about loans are: interest rates and annual percentage rates (APR). Interest is the percentage you pay each month based on the total amount borrowed (otherwise known as the “principal”). APR gives you the cost of the loan each year as a percentage by considering interest rates and fees.

These rates are decided by the type of loan and by various factors like your credit score. Knowing what an APR is, how it can affect your ability to take out loans, and how to find the best APR are three factors worth considering if you are borrowing money for a home or auto. Check out our credit union rates.

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Why APR is Important?

An easier definition of an APR is thinking of it as the price you pay to borrow money. People need to borrow money for numerous reasons, and an APR will apply when you:

  • Buy an auto
  • Apply for a credit card
  • Finance a home
  • Start a small business
  • Get student loans

The rate will determine how much each of these financial options cost over the lifetime of the loan.

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Fixed vs Variable APR

The two main types of APR on a loan include fixed APR and variable rate APR. A fixed APR is predictable and will not alter through the course of the loan term. This could be beneficial if a downturn in the economy causes interest rates to spike.

Variable rate APR is based on an interest rate index, which is commonly posted in the Wall Street Journal. An interest rate index sets the baseline for the rate a lender can charge on a loan with a variable rate. If you believe the economy will improve over time and that rates will decrease, a variable APR could be more beneficial.

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What are Typical APRs?

Whether you are buying a house, applying for college, or thinking of a new car, their respective loans will come with different annual percentage rates and interest costs. A car costs one-tenth of a home and its loan term could be relatively short—less than five years. For this reason, the total interest cost of an auto loan is generally lower than a 30-year home loan.

When going through typical APRs, keep in mind there are many factors that determine what APR you receive for your loan.

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Auto Loans

Receiving the lowest APR for your auto loan depends on a few factors: the loan term, your credit score, and who is offering the loan. Autos are depreciating assets whose values decrease by about 10% to 15% each year for the first four years. If you don’t have a down payment or low APR, your auto could quickly turn upside-down—when the value of the auto is less than the money owed. At that point, selling your auto would be a net loss.

To avoid this, here’s what you need to know about auto loan APRs:

  • Credit score – Start with the most substantial factor: your credit score. Credit unions, banks, and dealerships will rank people into four FICO score categories: poor credit, average, good, and excellent. Depending on which category you fall under, you can expect to pay a few percentage points higher or lower.
  • Auto loan terms – Say you want a 2022 Honda at about $25,000. You have a good credit score and receive a 36-month loan. This will put you in the ballpark of $775 as a monthly payment. This same situation with a 72-month loan could be a $430 monthly payment. How enticing! You are paying $345 less each month. But this is where the trick comes in. The total payment on the car would be $27,800 for the first scenario and $30,700 for the second scenario. That’s a $2,900 increase on the total amount you will pay out. Be sure to use an online loan calculator to determine what’s best for your financial situation.
    • Credit Cards

Opening a line of credit on a credit card is a great opportunity to work on your credit score and to finance any immediate needs. Credit cards are great for:

  • Making large purchases
  • Having easy access to credit
  • Financing projects
  • Building credit

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Types of Credit Card APR

There are five common APRs that you might see in the terms and agreement.

  • Purchase APR – This is the rate you are billed for each credit card purchase.
  • Cash advance APR – Often higher than purchase APR, this is the cost of borrowing money directly from the card.
  • Penalty APR – This refers to the credit card balance. This is the APR your current rate could increase to if you are late in your payments, or a payment is returned unpaid.
  • Introductory APR – Most credit cards will start off with low introductory rates, but these promotions will only be available for a certain period. Be sure to know when it ends and what the new APR will be.
  • Balance Transfer APR – This determines the amount of interest you will pay on any amount you transfer from another account to your credit card.

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Home Loans

Buying a home is one of the biggest financial decisions people make in their lifetime. Loans will be in the range of hundreds of thousands of dollars, and upfront payments can be 10% to 20% of that. Mortgages are often paid over 15 to 30 years, making the interest rates and APR significant factors to how much your home costs.

When buying a home, here are some factors that affect APR:

  • Credit score – Much like for car loans, one large factor is your credit score. Having a poor credit score can increase your APR by a percentage point or more.
  • Down payment – The larger the down payment, the less you need to take out on loan and the less interest you will pay. Plus, there may be additional incentives that a financial institution will offer for higher down payments.
  • Loan term – Because of how interest accrues, the total interest paid on a home is roughly doubled when going from a 15 to a 30-year loan.
  • You can use the government home loan calculator to determine how much extra you will pay on your home loan by inputting the above values for your specific home.

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APR in Summary

For someone who’s wondering, “What is APR?” the simplest answer: it is the total cost to borrow money. APR considers interest rates and other fees associated with the loan. These percentages will be tacked onto home loans, auto loans, credit cards, and any other type of lending.

To lower your APR and save on accrued interest, try to fix any financial troubles you have before asking for a loan. Increasing your credit score can save thousands on car payments and tens of thousands on mortgages.

The content provided consists of opinions and ideas and should be used for informational purposes only. Mission Fed disclaims any liability for decisions you make based on the information provided. References to any specific commercial products, processes, or services, or the use of any trade, firm, or corporation name in this article does not constitute endorsement, control or warranty by Mission Fed.

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Consumer Financial Protection Bureau. Explore interest rates.

Urban Institute. Millennial Homeownership.

Pew Research. Are young adult movers renting or buying?

This information is provided for educational purposes only. All loan products, rates and terms above are provided for illustrative purposes only. Must meet membership and account criteria. All loans are subject to credit approval.

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