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Editor’s Note: This story originally appeared on The Penny Hoarder.
If you’ve been researching new credit cards or looking at refinancing your home loan, you’ve probably noticed the term APR popping up everywhere. APR stands for “annual percentage rate” and, in terms of need-to-know financial information, understanding APR is pretty high on our list.
In this article, we’ll go over the basics of APR — what it is, how to calculate it, and how to improve it — so that you can be an informed borrower.
What Is APR?
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APR stands for annual percentage rate. It represents the yearly interest and associated costs of a loan by including loan-specific fees like the loan origination fees or mortgage insurance. You’ll find APR listed for credit cards, auto loans, mortgage loans, personal loans, and most other lines of credit. In fact, lenders are required to disclose a loan’s APR to the borrower thanks to the Truth in Lending Act (TILA).
Because the APR takes into account some of the fees of a loan, APR is often a more accurate representation of the cost of borrowing than the interest rate alone.
For example, a mortgage loan may tout a low interest rate through discount points but then have higher fees, while another may have a higher advertised interest rate but lower fees. Interest rates alone may be misleading, so looking at the APR will allow you to more accurately compare the overall cost of these two loans.
Essentially, the higher the APR the higher cost to borrow and vice versa. While not all fees are included, APR is a good place to start comparing lines of credit.
The Two Types of APR
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There are two types of APR: fixed APR and variable APR.
Just like it sounds, fixed APRs don’t change. The rate that you locked in at the onset of the loan stays with you for the term of the loan. Accordingly, fixed APRs are more predictable than variable APRs. The actual rate you’re offered is dependent on the market conditions (and your credit score) at the time of the loan/application.
While it is possible for this rate to change, the lender is required by the Consumer Financial Protection Bureau (CFPB) to notify you in writing.
Variable APRs are tied to an index interest rate, such as the Prime Rate from the Wall Street Journal. This underlying rate fluctuates with economic conditions and, therefore, variable APRs fluctuate as well. Basically, when the index rate goes up, your variable APR goes up.