APR stands for Annual Percentage Rate. It is what most people refer to as “interest” and while this is true, there is more to it than that.
Interest is a general term, that means the amount charged for the use of borrowed money. Borrowed money can mean a loan, or it can refer to a line of credit used by a borrower. Interest can be a percentage of the amount borrowed, or can be a flat fee charged by the lender. In some cases, loans and credit cards have both, and charge annual fees as well as a percentage.
Because interest is a general term, it can often be misleading. The best bet is to educate yourself on what each term really means, because some lenders might try to mislead you intentionally.
APR vs. Interest
APR is very specific. It tells you what the interest rate will be for a loan over the course of 365 days.
For example: you take out a loan for $1000, with an APR of 30%. This means that over the course of the loan you will be paying $300 in interest charges. All combined, when the year is up you will have repaid a total of $1300, the principle, plus the interest.
Pretty straightforward, right?
Now, let’s say you took a loan for $1000, with an interest rate of 30%
This is not 30% APR, but 30% interest. Then you come to find out that the 30% is charged every month. After one month, you owe $300 on a $1000 loan. That isn’t 30% APR, that’s 304% APR.
Are you starting to see the difference? Getting APR and interest mixed up could cost you a lot of money.
Simple vs. Compound
That was a very simple example, but the truth is that most lenders and credit card companies never keep it simple.
Simple interest is only charged on the principle amount borrowed. In the above example, that 30% a month interest was only charged on the $1000 initially borrowed. Compound interest allows interest to be charged on the interest, so that in the second month instead of charging 30% on $1000, they charge 30% on the new total of $1300.
It can add up at a dizzying rate.
When dealing with APR, this is not a factor. But if you are being offered an attractive “interest rate” double check to see if it is simple interest, or compound interest.
Fixed vs. Variable
Even short-term loans that don’t last for an entire year have an APR. And over the course of a year, some loans will have varying levels of APR.
When a loan has one rate of annual interest, it is called fixed. The percentage will not change for the life of the loan. But other loans may offer an introductory period with a lower APR, and then raise the rate on you. These are called variable interest loans.
Don’t assume the APR on your loan is fixed – make sure of it. Or the great deal you got on a loan may turn out to be something you didn’t plan for.