One of the most important elements of finding a loan or securing credit is understanding what it costs to borrow that money. But when the first statement arrives, it might not always be clear what went into calculating the monthly payment amount. Every lender is different when it comes to what’s included, but by understanding the APR, you can better prepare for what you’ll pay.

What goes into APR?

APR, or annual percentage rate, is often thought of as another word for interest. However, interest rate is only one factor that goes into calculating APR. Taking into account every cost associated with a loan, APR is designed to give you an overall picture of how much you should expect to pay for borrowing. Depending on the type of loan, factors can include interest rate, transaction fees, penalties, closing costs, GAP coverage, taxes and other charges. While not all of these factors may apply, APR should help you make a high-level apples-to-apples comparison of your loan and credit options.

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Fixed APR vs. Variable APR

While it may seem obvious that a variable APR can change and a fixed APR is set in stone, this isn’t quite the case. A variable APR changes with the index interest rate—a benchmark rate based on current market conditions. A fixed APR can change as well; however, it is usually required that the lender provide notification of the rate change, and it cannot apply the rate to any new purchases until after you receive the notification. So while both can change, fixed APR offers more consistency—though often at a slightly higher rate—while variable APR offers the possibility of lower rates, with the risk of increases at any time.

Credit Cards and APR

While APR is rarely a straightforward measure, it is further complicated when it comes to credit cards. Several types of APR can apply depending on the method of transaction, penalties and promotions. When selecting a credit card, be sure to consider how you plan on using the card and use the correct APR in your comparisons. Common types of APR include:

  • Purchase APR: Based primarily on interest rate, this is the APR that is charged when you make a purchase with your credit card. Most credit cards have a grace period—usually the end of the month—during which, if you pay the full balance, no interest charge will be applied.
  • Balance transfer APR: In addition to any interest accrued on an outstanding balance, credit cards will often charge an additional fee for balance transfers (usually 2–3 percent of the amount transferred) that will factor into the APR.
  • Cash advance APR: While there is usually no fee for cash advances with your credit card, the interest rates are often extremely high. Only take out a cash advance when absolutely necessary.
  • Discounted APR: Credit cards will often offer an introductory discounted APR for purchases and balance transfers to entice new customers. This can be beneficial if the balance is paid off before the end of the promotion, but once the term has ended, rates can increase significantly.
  • Penalty APR: Failing to make the minimum required payment can trigger a penalty APR. Even if the payment is missed during a discounted APR period, the penalty rate incurred can be severe.

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