Any industry is easier to understand once you learn the jargon that comes with it and the world of personal finance is no different. Anyone who has a credit card has probably heard of APR, but not everyone knows how it works and how it affects your credit. In honor of Financial Literacy Month, it’s time to familiarize yourself with this familiar acronym.
What is APR?
Annual percentage rate, or APR, is the rate of interest you’ll pay when you take out a loan, such as a credit card or a mortgage. You’ll likely end up paying less interest on your loan if you can score a lower APR, but there are different types of APRs and varying ways to calculate them. Make sure you’re comparing apples to apples when you’re looking at the rates of two or more loans.
The annual percentage rate for a credit card is the amount of interest you’ll pay every year if you carry a balance. In the simplest of terms, if you have a card with a rate of 15 percent and you carry an outstanding balance of $1,000, you’ll pay $150 per year in interest on that $1,000. Additional fees, such as late fees or over-limit fees, are tacked on in addition to your APR when applicable.
The annual percentage rate on a mortgage typically encompasses the entire cost of your loan. For example, you might take out a mortgage with an interest rate of 4 percent, but with closing costs, points or other fees added in, your APR may be higher.
How APR Is Determined
Banks add a profit margin to national rates, such as the U.S. prime rate, to determine APRs on their products. For example, if the prime rate is 6 percent, the APR on your credit card might be “prime rate plus 6 percent” for a total of 12 percent. If the prime rate goes up by one-quarter of 1 percent, you can expect your APR to rise accordingly.
In most cases, the 2009 Credit Card Accountability, Responsibility and Disclosure Act prohibits credit card lenders from raising APRs during the first 12 months of issuance. Exceptions can include variable APRs and penalty APRs, which may occur if you miss a payment. Consumers must also receive at least 45 days notice before any APR increases.
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Why Your APR May Change
Other APRs are variable, particularly with mortgages. You can often get a lower initial rate on your mortgage if you agree to let the rate readjust at a predetermined time, such as after five years. A penalty APR may kick in if you fail to make at least the minimum payment on your credit card, mortgage or other loan. Penalty APRs on some credit cards can reach 29 percent or more.
How To Get a Low APR
APRs represent profit centers for banks and other lenders, so it can be hard to lower your rate after you’ve agreed to a loan. You can sometimes get a lender to knock down an APR with a simple phone call if you’ve been a good customer for a long period of time. You might also be able to find lower rates on products from competitors if you shop around2.
Financial Literacy Month stresses that creditworthiness plays an important role in your overall financial life. In fact, the best way to get a low APR is to have good credit scores when you initially apply for your loan. Borrowers with the highest credit scores are typically able to get loans with the lowest interest rates.