Financing
APR
The letters A P R show up everywhere these days. Credit card statements, automobile ads, and in conjunction with all types of loans.
But what do these letters mean?
The abbreviation stands for Annual Percentage Rate and there are actually two different types of APR to know about. The 'nominal' APR is the simple rate charged and totaled over one year’s time. The 'effective' APR includes the amount of fees plus compound interest over the span of one year. Compound interest is when interest is applied to the original amount borrowed plus the interest already accrued.
Why does the APR exist?
Suppose you are buying a new car and need a loan. The actual interest rate of your loan may be 7% but the APR can be higher. This is because the APR includes all fees you will have to pay in order to borrow the money. To keep lenders from offering very low rates (but tacking on high fees) the federal government required institutions to disclose the total cost for all money borrowed. This way, you can compare different deals without performing complicated calculations.
Now that you know the definition of APR, how can it be applied to everyday finances?
When you are looking to borrow money, whether it is through a credit card or a loan, obviously a lower APR is better. But it pays to understand how that APR works in each situation. Some companies may offer 0% APR on a purchase for one year. Miss any payments or don’t pay the amount in full after one year, then watch all of the interest you’ve not been paying get applied in a compounded manner. This can make a seemingly affordable purchase a money pit.
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