Your loan's APR reflects not only the interest rate but also the lender's costs in extending you the loan.
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The annual percentage rate, or APR, is the amount it costs a lender to offer you a loan or credit. Whenever you have a balance on the loan or credit, you’ll be required to make payments toward the balance as well as additional payments to pay the APR.
The APR is largely comprised of the interest rate, but it also includes other charges like fees. If you receive any discounts on your interest rate, such as by purchasing discount points, then those will also be factored into the APR.
For that reason, when you take out a loan, you’ll often be presented with both the interest rate and APR, and the APR will be a little higher since it includes the other costs.
Your APR will depend on your credit history; a better credit score means you may be offered better rates. The type of loan will also make a difference, as the following table shows:
|Loan Type||Average APR||Notes||Source|
|Credit cards||14.58%||Only accounts assessed interest||Federal Reserve, Aug 2020|
|Mortgages||2.81%||30-year fixed-rate mortgage, with 0.7 points purchased||Freddie Mac, Nov 2020|
|Auto loans||4.98%||New car, 48-month term||Federal Reserve, Aug 2020|
|Personal loans||9.34%||24-month term||Federal Reserve, Aug 2020|
|Student loans||2.75%||Undergraduate federal student loans||Department of Education, rates valid between July 1, 2020, and July 1, 2021|
You have to pay extra money to your lender for the favor of extending you the loan. That cost is expressed as a percentage called the APR.
The APR is baked into the payments to make each month to pay back the loan. Part of your payment goes to the loan principal — the amount of money you took out — and part of it pays the APR.
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Several factors go into determining the APR. The APR includes:
Interest is a cost added on to the loan principal as a percentage of the loan balance. If your loan has a 5% interest rate, then you owe 5% of the unpaid balance each month until the full balance is paid off.
Points include costs like the loan origination fees, which compensate the lender for its initial costs. Other costs, like broker fees, may also be included as points. Points, like interest, are expressed as a percentage.
(Read more about loan origination.)
You can also get discount points, which you purchase at the time you take out the loan in order to get a lower interest rate for the life of the loan.
One discount point may cost X amount of dollars and decrease your interest rate by Y amount of percentage points. The actual figures vary by lender.
Discount points have a high up-front cost, but you will break even after a number of years when the savings on interest outpace the cost of purchasing the point.
If you owe private mortgage insurance (PMI), it may sometimes be included in the APR. You’ll be required to pay mortgage insurance premiums if your down payment is less than 20%, for as long as your loan-to-value ratio remains above 80%.
Your payment schedule is the calculation of how many payments you need to make to pay off the loan.
The payment schedule is a function of how much of each payment goes toward the principal, how much goes toward paying off interest, and how much goes toward other costs, divided up over the number of years or months of the loan.
The finance charge is the actual dollar amount that it costs a lender to give you a loan. If the lender wants $1,000 to underwrite your loan, the finance charge is $1,000. That is the total cost accounting for interest, fees, and points.
It’s tempting to think of the APR as simply the finance charge when expressed as a percentage of the loan. But the finance charge doesn’t take the payment schedule into account, so two loans with the same finance charge may have different APRs if they have different payment schedules.
The Federal Reserve sets which costs must be disclosed in the APR. But some costs do not need to be included, although it’s up to the lender’s discretion. These include:
For mortgages only: Appraisals, home inspections, property survey fees, and title examination and title insurance fees
For all types of loans, including mortgages: Credit report, document preparation fees, fees for late payments, overdraft fees, notary fees
The two main types of APR are:
When your loan has a variable rate, the interest rate may increase at certain times during the life of the loan. Variable-rate APRs are tied to the value of an index that tracks the health of the economy, and the lender uses a formula to determine changes to the interest rate.
Examples of loans with variable-rate APRs include adjustable-rate mortgages and some private student loans. Usually, variable-rate loans have a fixed-rate period where the interest rate does not change for a number of years.
Variable-rate loans have government-mandated rate caps that limit how much your interest rate can increase. Rate caps apply to both quarterly interest rate increases as well as the total interest rate increase for the lifetime of the loan.
Variable-rate loans may have lower APRs at first, but increases in the interest rate may offset those early savings.
A fixed-rate loan has the same interest rate throughout the lifetime of the loan. Fixed-rate loans might have higher APRs at the onset, but over time they may save you money over variable-rate loans if you’re paying off the loan for a long time.
Most auto loans and personal loans have fixed-rate APRs because they have relatively shorter terms. Mortgages and federal student loans can also be fixed-rate.
The annual percentage yield, or APY, is the opposite of the APR. You’ll see it associated with savings accounts and interest-bearing checking accounts to show you how much interest you can expect to earn.
Like the APR, the APY is more than just the interest rate; it’s also a function of how often that interest compounds, so that you’re earning interest on interest you already earned.
Interest that compounds at a faster rate — whether daily, monthly, or annually — will earn a slightly higher APY. Depending on your bank or credit union, you may earn between 0.01% APY and 2.5% APY or more.
You can get a tax deduction for interest paid on some types of loans. However, not all loans are eligible, and you generally can’t write off the payments you make toward the loan balance.
The following types of loans have tax-deductible interest:
Student loans. Learn how to claim the student loan interest tax deduction.
Auto loan interest, but only as a proportion of the amount of time you use the car for business, such as driving for Uber or Lyft
The best APR for you depends on your financial situation and what you need the loan for. If your credit is good, you can get a better APR. You may also be able to get a lower APR if you can afford to pay the loan off faster, which means having a shorter payment schedule.
See the table at the beginning of this page for average APRs per loan type.
While it is possible to get 0% APR on a loan, you likely won’t save any money by doing so. That’s because the figures that would normally comprise the APR are still baked into the loan payments you make. (The lender has to make money somehow!)
In addition, you’ll lose any relevant tax deductions for interest because you’re not technically paying interest.
It is possible to get a credit card with 0% APR. With this type of credit card, the 0% APR promotional period lasts for around 12 to 18 months, after which you have to pay the full APR on the remaining balance.
For people who have a lot of credit card debt, a 0% APR credit card can help them consolidate that debt and make it easier to pay off. But when the promotional period ends, you’ll have to pay the usual credit card APR, which may be much higher.
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