Personal Finance 101: What is APR, Anyway?

APR is one of those financial terms you might see everywhere. But what precisely does it mean?

When you borrow money from someone, whether it’s a bank, credit union or other establishment, you have to pay interest on what you borrow. It’s how these guys make their money. Your interest rate is calculated by several variables, such as your credit history and debt-to-income ratio.

Your interest is set for the year, and that interest rate is called an annual percentage rate (APR). This can be one of the more confusing concepts when dealing with finance, so let’s back up a little bit.

What does APR mean exactly?

APR is one of those financial terms you might see everywhere. But what precisely does it mean?

Your APR is described as the interest rate that someone is charged in a certain year on an amount borrowed. If you are told your prospective interest rate is “prime plus 13.4 percent,” that means you are charged what the national prime interest rate is, plus that 13.4 percent. Since the prime rate is 3.25 percent, you’ll actually be paying 16.65 percent.

Make sure you know if you are paying a fixed rate or a variable rate. Fixed rates are incredibly rare these days, because of the Credit Card Accountability and Responsibility Act of 2009. Since then, variable rates have been almost exclusively offered by creditors. By carefully reading and understanding the terms and rates in a credit line, you can evaluate the total cost of the loan. And this gives you leverage as a consumer.

What a lot of people don’t understand is that, as a purchaser of credit, you have power. One company quotes you an APR, and you don’t like it. You can go to another company, tell them what the first company quoted you, and tell them to do better, or you’ll go back. Believe it or not, you can shop around for loans and credit lines. In fact, it’s recommended.

And if there’s just no good rate for you, or you’re not comfortable taking on more debt, you can always do what Nancy Reagan told you: “Just Say No!”

Mortgage Loans and APR

If you’re shopping for mortgage loans, be careful of when you receive a quote. There can also be private mortgage interest, administration and processing fees, and other fees that might not be on the quote. So your actual loan could be quite a bit more expensive than what they say, if they’re just quoting the bare minimum. They’re going to make persuasive arguments on why it would be easier to just tack these fees onto the life of the loan and pay it off over time. If at all possible, don’t do this. You’ll end up accruing interest on these fees as well, so a one-time payment could end up costing you so much more than you think.

Even with all of your careful navigating, there are some pitfalls to look for and avoid:

  • If it’s too good to be true, it probably is.
  • Don’t let yourself be hoodwinked! Ask up front for a clear definition of the loan parameters, fees, and what’s included and excluded.
  • Get preapproval from a few different companies before accepting any or even before you start shopping for homes. Nothing is more heartbreaking than finding your dream home and not being able to finance it.
  • Be careful of 0-percent APR introductory rates. Sure, you’ll have 0 percent the first year, but you’re likely to have 20 to 25 percent rates after that, with fees for cancelling the card.

You worked hard to earn your money, and you should work hard to make the most of it. Do your research, remember that you can say no, and shop around. If you utilize these tips, you’ll be much better equipped to handle the world of credit.

Photo courtesy woodleywonderworks