One of the most important parts of finding a loan or securing credit is understanding what it costs to borrow the money. But, when the first statement arrives, it might not always be clear how the monthly payment amount was calculated. Every lender’s approach is different, but by answering the question “What is APR?” you can better prepare for what you’ll pay.

What goes into the APR?

The APR, or annual percentage rate, is often thought of as another word for “interest.” However, the interest rate is only one factor in the APR. Taking into account every cost associated with a loan, the APR is designed to give you an overall picture of how much you should expect to pay for borrowing.

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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, the APR should help you make a high-level, apples-to-apples comparison of your loan and credit options.

Fixed APR vs. variable APR

Although it may seem obvious that a variable APR can change and a fixed APR is set, this isn’t quite the case. A variable APR (on a home loan, for example) changes with the index interest rate—a benchmark rate based on current market conditions. A fixed APR offers more consistency—though often at a slightly higher rate—while a variable APR offers the possibility of lower rates, with the risk of an increase at any time.

When making mortgage choices, you can even use APRs to compare lenders in general. The APRs provide good barometers for other lending practices.

Credit cards and APR

The APR is rarely a straightforward measure, especially 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, consider how you plan to use the card and make sure that you use the correct APR in your comparisons. So, what is APR? Common types 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 is charged.

Balance transfer APR: In addition to interest accrued on an outstanding balance, credit cards often charge an additional fee for balance transfers (usually 2-3% of the amount transferred), which factors into the APR.

Cash advance APR: There is usually a fee for cash advances with your credit card, and the interest rates are often higher than the regular APR. Take out a cash advance only when absolutely necessary and you’re sure what the APR is.

Discounted APR: Credit cards often offer a discounted APR to entice new customers and as a promotion to existing cardholders. This rate can be beneficial if the balance is paid off before the end of the promotion, but once the term has ended, rates will increase back to the standard APR.

Penalty APR: Failing to make the minimum required payment can trigger a penalty APR.

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