What is APR and How Does It Affect Your Personal Loan?

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Point of Interest

APR is a useful tool for calculating how much in total a loan will cost to take out and repay.

Annual percentage rate (APR) is a comprehensive measurement of how much it costs to borrow money. The APR meaning of a loan tells you how much you will pay per year on it, and it includes all the associated costs, such as fees. Because it takes into account more information than just the interest rate, APR is a more accurate tool for showing how much a loan will cost.

APR is one of the best measurements for comparing different lenders and seeing which one offers the best loan for your needs. In a survey performed by YouGov in late 2019, 24% of respondents couldn’t recall what their APR was. A lower APR is always going to be better if all else holds equal. While it’s true that the loan with the lowest interest rate will often have the lowest APR, this isn’t always the case, and APR is essential when deciding between two loans that have the same interest rate.  Not only does APR help with choosing the right loan, but it is one of the best measurements for keeping the borrower aware of how much they owe annually once they obtain a loan.

What is APR?

APR differs from interest rates in that it considers fees and other costs on top of the interest rate and presents them as a total percentage of the loan amount per year. A Basic APR definition is that it is the annual rate charged for a loan.

It’s important to note whether your APR is fixed or variable. Fixed APR doesn’t change over the life of the loan, but a variable APR can change depending on the market environment. Fixed APR loans are more accurate regarding how much personal loans will cost over their life, while variable APR personal loans technically have a chance of becoming less costly over the life of the loan. Keep in mind with variable APR, though, that it also has a chance of becoming more expensive over the life of the loan.

Why it’s important

Understanding APR helps you save the most money when taking out a personal loan. While it may be a bit of a headache to get used to concepts like APR, this measurement is an essential tool for being strategic about taking out credit. 

Let’s say a borrower wants to take out a $10,000 loan, and they’re shopping between two lenders. Both lenders offer the borrower a loan of the needed amount, but one lender offers its terms in interest rate while the other offers its terms in an APR. The lender with the lower APR will most likely have the lower cost over the life of the loan.

How it’s calculated

You combine the cost of fees with the total interest to be paid throughout the loan term. Then you divide that sum by the dollar amount of the loan. Next, you take that number and divide it by the number of days in a year (365). Finally, you multiply the outcome of that by 100. This will result in the APR of the loan.

APR formula:

Example: a borrower takes a $10,000 personal loan with a 5% interest, $300 in fees, and a 6-year term length

  • Add fees ($300) and total interest ($1,595.55) to get $1,895.55
  • Dive that number by the total loan amount ($10,000) to get 0.18955
  • Divide that by the number of days in the loan term (6 x 365 = 2,190) to get 0.00008655479
  • Multiply that by the number of days in a year (365) to get 0.03159249835
  • Multiply that final number by 100 to get your APR of 3.16%

Visualize it here:

Ways to secure a reasonable APR

  1. Shop around between lenders: Different lenders offer different rates, fees, and terms on otherwise comparable personal loans. Talk with multiple lenders and see who offers the best APR.
  2. Pay bills on time: Keeping up with monthly bills will help to establish good credit and reduce the risks of hurting your credit rating.
  3. Use a low-interest credit card: Using a credit card can help you build good credit bu
  4. t only if it doesn’t go delinquent. Making sure that the credit card you use has a low-interest rate will help to reduce the risk of delinquency while you build your credit rating.
  5. Improve your credit score: The higher your credit score, the better conditions many lenders will offer you on a personal loan. The lower your credit score, the worse these offers will get. There are bad credit loans out there, but rates won’t be the most favorable.
  6. Pay off your credit card monthly: Keeping your credit card at a zero balance from month to month can build your credit rating while minimizing the interest you pay.

The final word

APR is a valuable tool for helping to determine the borrowing cost of a personal loan. Comparing APRs between personal and emergency loans allows borrowers to make financial decisions on which lender to borrow from. APR is different from interest rates in that it includes the interest rate of a loan plus any associated fees with that loan. 

Like with interest rates, whether the APR on a given loan is fixed or variable plays a significant role in how accurate it is for determining how much the loan will cost over its life.