Understanding the Difference Between Interest Rate and APR
Interest rate and annual percentage rate, or APR, are terms you'll hear a lot when applying for a credit card or if you already have one. They define how much you're paying to borrow money.
If you understand the difference between interest rate and APR, and know how each amount is calculated, you'll be in a better position to choose between credit card offers. It'll also help you evaluate mortgages and other types of loans.
APR tells you your total cost of borrowing a certain amount of money. The difference between interest rate and APR is that APR takes into account not just the original amount you borrow, but any fees charged by a lender or credit card issuer. In this sense, APR provides a clearer picture of how much it'll actually cost you to borrow money.
Consider if you were to purchase $100 in a month on a credit card with an interest rate of 12%. If interest was charged on an annual basis, you'd be charged $12 at the end of the year.
The APR charges are more complex. If you don't pay your balance in full when you receive your bill, credit card issuers will typically charge an APR on your daily balance. This increases throughout the month as you make additional purchases and decreases when you make a payment. The APR would also be applied to prior interest and fees added to your account, not just the amounts you charge to buy items.
Use APR to compare credit card offers
When you're comparing credit offers, it's important to understand how APR affects the amount you pay to revolve a balance. If you plan to pay off your balance each month, APR may not be a large factor in choosing a card. But if you anticipate that you may sometimes pay less than your full balance, a lower APR can reduce the amount you owe in interest and fees.
You may also want to consider how you intend to use the card. Credit card APRs may vary based on type of transaction, such as a balance transfer or a cash withdrawal versus a retail purchase. You may also be offered an introductory APR that will reset to a higher amount a few months later.
How to get a lower APR
Paying attention to stated APRs on credit card offers can help you stretch your dollars and make better borrowing decisions. Note that credit cards often charge variable rates, so your APR can go up and down as its underlying index rate, like the prime rate, changes.
When you're applying for a credit card or mortgage, ask about the lowest rate available. If you're not offered this rate, you may want to take the following steps to improve your overall financial picture before applying for a new account.
- Pay down existing debt to help improve your credit score
- Close inactive credit cards to limit the number of open accounts on your credit report
- If you're buying a home, adding to your down payment may help you get a lower interest rate because lenders may view your smaller loan as less risky
- Spend some time strengthening your credit score before applying for a new loan so you can qualify for better rates
Understanding how APR is charged on your credit cards or loans can help you determine which financial products work best for you.
A few financial insights for your life
This information is provided for educational purposes only and should not be relied on or interpreted as accounting, financial planning, investment, legal or tax advice. First Citizens Bank (or its affiliates) neither endorses nor guarantees this information, and encourages you to consult a professional for advice applicable to your specific situation.