What is APR and How Does Credit Factor in Calculating It?

The financial world is full of abbreviations, each with its own significance that can lead to either  a bright financial future or a dim one. But what do they all mean? While that would take a book to explain, one that is more easily explained, and incredibly important to understand, is APR.

APR is one of those frightening financial terms that no one ever bothered to explain to you, but it is a necessary piece of jargon to know in order to navigate your financial world and give you the purchasing power that you deserve. Below is an explanation of that mysterious term and everything you need to know about it.

What is APR?apr

APR stands for annual percentage rate, and is most easily understood as the interest rate for not just one month or billing cycle, but for an entire year. Through understanding your APR, you can determine your DPR, which is your daily percentage rate, and then determine the amount of interest that you owe from there as well. Though the annual percentage rate is most commonly associated with larger loans such as mortgages, APR can also be broken down into smaller categories that are associated with your credit card and even some of your daily credit card purchases:

  • Introductory APR is a lower form of the rate that is temporarily applied to new cardholders, and made especially for people who have never had a credit card, or who have little credit to work with. This can apply to all purchases and monetary transactions with the credit card company.

  • Purchase APR is the interest rate applied to your daily credit card purchases, but over the course of the year. If you deal with no other types of APR in your credit card-holding lifetime, then this is the one that you will work with the most.

  • Cash Advance APR is the interest rate that your credit card company charges you for taking cash from your credit card. This APR has no grace period, but can sometimes vary depending on how you take out that cash, such as whether you take it as cash or as a check.

  • Penalty APR is typically the highest type of APR that you can have, and it is added to your balance after you have violated some term of your contract. These are often the result of missed payments, which is yet another reason that you should pay your credit card balance in full at the end of every billing cycle.

  • There are also separate APR categories for home loans and auto loans.

You can avoid paying APR if you pay your debts in full at the end of every month, but the moment that you start to pay off a credit card balance, you must pay the interest on that as well.

How is APR Determined?

APR is determined differently based on the type of loan in question and the type of APR in question. The traditional annual percentage rate for a typical credit card, though, is calculated based on the US Prime Rate, as reported in the Wall Street Journal, and the margin with which that varies from bank to bank. The prime rate is added to the margin and the APR is produced. It is a simple calculation for credit cards, but some institutions include their own fees and other factors in their calculation, so if you would like to calculate your own APR, you can use a spreadsheet or have a personal financial advisor do it for you.

Sometimes, this rate changes, and it can happen for multiple reasons. For instance, the financial institution can charge you a different Penalty APR if you violate your contract. They can also change their APR based on a change in policy at the institution itself. Your financial institution is legally obligated to give you a notice 45 days in advance before the change goes into effect so that you can financially prepare, whether that means setting aside a little bit of extra money every month or by switching financial institutions entirely. For the first year that you have your credit card or other loan, your lender should keep your rate the same.

Where Does Your Credit Come Into Play?

Your credit score directly influences what your APR will look like. The higher that your FICO score is, the lower that your APR will be, and the less expensive your debt becomes. Brian Hill, auto loan expert, illustrates this point by showing that people with a credit score in the 690-719 range have an average APR of 5.071 percent, while those with a credit score in the 620-659 range have an average APR of 9.882 percent on their auto loans. Those numbers are specific to auto loans, but the trend is all across the board when it comes to the relationship between credit and APR.

If you seek out a loan, and you do not like the APR that the lending institution has extended to you, then instead of trying to negotiate your APR, you should try to improve your credit score instead. This will not only help you reduce your APR eventually, but will afford you more financial opportunities than simply lowering your APR will. In raising your credit score, you demonstrate to lending institutions that you have decreased the risk that you pose to them when they lend to you, thus making them more likely to lend to you for whatever purchase you want to make in the future.

Your annual percentage rate for your credit card, auto loan, or home loan does not have to frighten you or come as a shock to you any longer. Now, you know how to calculate it, what influences it, and even how to change it simply by making adjustments that will help you raise your credit score. Raising your credit score by as little as 20 points can help you have a 2% lower annual percentage rate, so it is always worth at least a valiant effort.