What is APR and how is it calculated?

Annual percentage rate (APR) represents the price to borrow money, according to the Consumer Financial Protection Bureau (CFPB).

Read on to learn more about APR, including why APR is important, how APR works, the difference between APR and interest rates, and the different types of APR.

Key takeaways

• APR is the price you pay for a loan. It typically includes interest rates and fees.
• APR can sometimes be the same as a loan’s interest rate, like in the case of most credit cards.
• APR may be fixed or variable, meaning the rate may stay the same or it may change with market factors.
• Fixed and variable APRs could still change based on other factors, but lenders typically have to notify borrowers upfront or before a change occurs.

If you’ve ever applied for a car loan, a mortgage or a credit card, you’ve probably seen the term “annual percentage rate” (APR). 

APR will be a factor in how much you pay to borrow money each month. In the case of credit cards, it’s especially important if you carry a balance from month to month. 

Many credit card companies offer a grace period for new purchases. If you pay off your balance on time every month, you won’t be charged any interest. If you carry a balance from month to month, you’ll be charged, based on the APR, for the unpaid portion.

APR vs. interest rate

It’s easy to lump interest rate and APR into the same category, but they’re actually two different types of rates.

The interest rate is the percentage charged on the principal loan amount. In the case of a credit card, that loan amount would be the card balance.

Compared with the interest rate, “APR is a broader measure of the cost of borrowing money,” according to the CFPB. It includes the interest rate plus other costs, such as lender fees, closing costs and insurance. If there are no lender fees, the APR and interest rate may be the same—and that’s typically the case for credit cards.

APR vs. APY

You may have also seen the term “APY.” And while it might seem similar to APR, it’s actually much different.

APY stands for annual percentage yield. And it’s sometimes known as EAR, or effective annual rate, instead. While APR measures the amount of interest you’ll be charged when you borrow, APY/EAR is the measure of the interest you earn when you save. That’s why APY/EAR typically applies to money you place in a deposit account—not to money you borrow.

Want to learn more about the APY/EAR? Check out this deep dive into the difference between APR and APY/EAR.

Understanding APR can help borrowers make more informed credit decisions. It gives an idea of how much it costs to borrow money. And if you’re deciding between credit cards, APR is one factor to compare to help determine which credit card might be best for you.

Banks use an APR calculation formula to determine how much interest borrowers must pay on their outstanding balances. It can be calculated daily or monthly, depending on the card. Calculating the APR for a loan requires knowing:

• The loan balance
• How many days there are in the loan term for the year
• The interest rate of the loan
• Any fees related to the loan

And remember that some accounts have multiple APRs. 

Card issuers are required to disclose how they calculate APRs. Check the disclosures and terms of a card before you apply. If you want to learn more about credit card APR calculations, check out this deep dive about how to calculate APR on a credit card.

APR varies with different loan types

Keep in mind that the costs that go into an APR calculation can vary based on the type of loan you’re seeking. 

For example, an APR for a mortgage could include the interest rate, points, origination fees and more. 

In the case of an auto loan, the APR is determined based on a number of factors. Those can include credit history, loan amount, down payment and the age of the car.

APR can be either fixed or variable. So what’s the difference between fixed APR and variable APR?

• Fixed APR: A fixed APR generally doesn’t change over the life of the loan. But as the CFPB notes, “fixed” doesn’t mean “the interest rate will never change”—but the issuer generally must notify you before the change occurs.
• Variable APR: A variable APR is tied to an index interest rate, such as the prime rate. If the prime rate increases, so does the variable APR. So while the loan may have a lower APR at first, the rate can increase over time. 

Understanding the different types of APRs can help borrowers choose the card that’s best for them and their spending habits. Keep in mind, the applicable APR can sometimes depend on the type of transaction.  

The APR can also be different depending on the type of credit you’re applying for. A credit card’s APR is usually higher than that of a car loan or a home loan. And how the credit card is used can affect the rate, too.

Here are a few types of APRs to be aware of:

Purchase APR

A credit card’s purchase APR is exactly what it sounds like: It’s the rate that’s applied to purchases made with the card.

Cash advance APR

The cash advance APR is the cost of borrowing cash from a credit card. It tends to be higher than the purchase APR. 

Keep in mind that there are other transactions that might be considered cash advances—even if actual cash never touches your hands. These include buying casino chips, purchasing lottery tickets or exchanging dollars for foreign currency. 

And these transactions usually don’t have a grace period. This means that interest will likely start accruing immediately.

Penalty APR

If a borrower violates the terms of their card’s contract—by doing things like missing a payment or being late with a payment—the APR on their card may increase for a period of time. Be sure to check your card’s terms and any notices the issuer sends related to your account.

Promotional APRs

Introductory APRs: A new credit card may come with a lower, limited-time APR. Different card issuers have different standards for what qualifies as an introductory APR, so it’s important to read the terms and conditions. For example, you may only get the introductory APR for purchases above a set amount.

Balance transfer APRs: A balance transfer may qualify a borrower for a special APR on a new or existing credit card. While this promotional period may last for six to 18 months, the low balance transfer APR may only apply to the balance transferred. 

A separate APR can apply for new purchases, even while the balance transfer APR is in effect. So make sure you review all the interest rates—in case there are multiple—and any fees, like a balance transfer fee or foreign transaction fees.

Your credit history, credit scores and credit activity can affect what APR you’re offered—and whether it changes. It’s important to understand the terms and conditions associated with your credit card. Be mindful of the APR, because an introductory rate may increase after the introductory period expires. There are other factors that could affect the rate, too.

In general, increases to the APR will apply only to future purchases, not to your existing balance. But the APR on your existing balance could increase if you’re more than 60 days late in paying your bill.

Your credit card’s APR can be found in your account opening disclosures as part of the Schumer box and on your monthly credit card statement. In many cases, you can find your current APR—and determine whether it’s based on the prime rate—by looking at the section about interest charge calculation.

How do you get a low-APR credit card? There’s no single answer. But maintaining good credit scores can make you a better candidate for cards with low APRs and additional benefits. 

There’s no magic formula for building credit, but these principles from the CFPB may help:

1. Use your current card responsibly and pay your bills on time. Late payments can have a negative effect on your credit. Consider automating payments or setting reminders on your phone to help you remember. 
2. Avoid getting too close to your credit limit. Scoring models factor in how close to “maxing out” you are, known as a credit utilization ratio. Experts say not to use more than 30% of your available credit across all revolving credit accounts. If you have a single credit card with a $5,000 credit limit, that means not going above $1,500.
3. Keep building your credit. Credit scores are based on your experience with credit. That means the longer your credit report shows you paying your loans on time, the better.
4. Apply for only the credit you need. Be careful about applying for a lot of credit over a short period of time. It could indicate to lenders that your financial situation has changed negatively—even if that’s not the case.
5. Monitor your credit. Everyone is entitled to free credit reports from each of the major credit reporting agencies through AnnualCreditReport.com. CreditWise from Capital One is another tool that can help you monitor and track your credit. Using it won’t affect your credit, and it’s free for everyone. 

APR is just one factor to consider when comparing credit cards. But knowing what it is and understanding how it impacts your required monthly payments can help you make an informed decision.

Remember, financial situations vary from person to person, so it’s tough to say what a bad APR for a credit card is. If you’re thinking about applying for a new credit card, keep these things in mind:

• APR and interest rate are two different things.
• Fixed APRs generally don’t change over the life of a loan.
• Variable APRs can fluctuate based on index rates, such as the prime rate.

How you plan to use your card can affect rates—there may be additional APRs based on the transaction.

APR is the cost of borrowing expressed as a yearly percentage. This figure is calculated based on the loan’s interest rate and any fees that are part of its terms. The APR may be fixed or variable, depending on the type of loan. 

Knowing a bit more about how APR works can help you make an informed choice about loans and credit cards. If you’re interested in a low-rate credit card, consider checking out 0% introductory APR credit cards from Capital One.