What is APR?

What APR actually measures

Two lenders offer you $10,000 over three years. One quotes 8% with a $500 origination fee. The other quotes 9% with no fee. Which is cheaper?

You cannot answer that from the interest rates, and that is exactly the problem APR was created to solve. The Truth in Lending Act requires lenders to disclose a single annualized figure that folds the interest rate together with certain required costs of getting the loan, so two offers become comparable.

APR = the rate at which the present value of every repayment equals the money you actually receive

Run those two offers through the APR calculator and the fee-bearing loan comes out more expensive, despite the lower headline rate. That inversion is common, and it is the whole reason the disclosure exists.

What gets included, and what does not

For a closed-end loan — a mortgage, auto loan or personal loan — the APR generally includes the interest rate plus finance charges you must pay to get the credit: origination fees, discount points, mortgage insurance premiums and certain closing costs.

It generally excludes costs you would incur regardless of financing, and charges that depend on your own behavior:

The exclusions matter. An APR describes the cost of a loan you repay exactly on schedule. It says nothing about what happens if you miss a payment.

Credit card APR is a different animal

On a credit card, the APR is the interest rate. Card issuers are not required to fold the annual fee into it, so a card advertising 21.99% APR with a $95 annual fee costs more than 21.99% a year to carry — the fee simply sits outside the number.

A single card also carries several APRs at once, and they are rarely the same:

• Purchase APR — applied to everyday spending you do not pay off in full.
• Balance transfer APR — applied to debt moved from another card, often with a transfer fee of a few percent.
• Cash advance APR — usually the highest, and typically with no grace period, so interest starts the day you withdraw.
• Penalty APR — a higher rate an issuer may apply after you fall behind.

Fixed versus variable

Most US credit card APRs are variable: they are set as an index plus a margin, and the index is typically the prime rate. When the prime rate moves, your APR moves with it, usually within a billing cycle or two, and the issuer does not need your agreement.

A fixed APR on an installment loan means the rate is locked for the term. Your payment does not change, and neither does the total interest.

Where APR misleads

Comparing across different terms. A 6% APR over seven years costs far more in total interest than a 7% APR over three years, because you are borrowing for more than twice as long. APR normalizes the rate, not the duration. Compare total cost of credit as well.

Comparing across loan sizes. A flat fee is a much bigger share of a small loan. The same $300 fee lifts the APR on a $2,000 loan far more than on a $40,000 one.

Short-term credit. Annualizing the cost of a two-week loan produces a very large number, which is accurate but not intuitive. For very short-term borrowing, the total dollar cost is the figure to look at.

"Representative" advertising. An advertised APR may be the rate offered to most approved applicants, not to everyone. Your actual offer depends on your credit profile and comes after the lender has assessed you.

How to use APR well

1. Compare APRs only between offers of the same size and the same term.
2. Alongside the APR, look at the total amount repayable — the number that tells you what the loan actually costs in dollars.
3. On a credit card, check all four APRs and the annual fee, not just the headline.
4. Ask the lender which fees are inside the APR and which are not. They have to tell you.